Summary

Over the past week, the Hong Kong stock market has once again fallen under the joint influence of weak economic data, unclear expectations for future policy direction, and volatility in overseas markets, giving up the gains made earlier due to the expected rate cuts. This also conforms to our judgment. On the one hand, this round of interest rate cuts has been short and the market has jumped the gun, so when the rate cuts are realized, it may be close to the end of the trading. The easing policy has already passed halftime. On the other hand, the impact of interest rate cuts on the Chinese market is indirect and secondary, and domestic factors will play a greater role. In particular, recent weak data and unclear expectations for future policy direction may be more important factors affecting the market trend. Product structure, 10-30 billion yuan products operating income of 401/1288/60 million yuan respectively.

In summary, 1) The "rate cut trade" will initially play a role through the denominator end, so those assets that are sensitive to liquidity, especially those that have lagged behind in the early stage, have greater elasticity in the initial period. However, due to the particularity of this rate cut cycle, the rate cut cycle is shorter and there are fewer, plus the market has jumped the gun, which may cause overdrawn and fallback even before the rate cut is realized.2) The "Trump trade" has affected the performance of some sectors.3) The internal environment is the key to the direction of Hong Kong stocks. Recent weak data and unclear expectations for future policy direction may be more important factors dragging down the market trend. Against this background, the Third Plenary Session held this week has attracted widespread attention, but its focus is more on long-term reform direction rather than short-term stimulus. However, this meeting has analyzed the current situation and tasks, emphasized the realization of the annual development goals, and also mentioned issues such as real estate and local debt, so policies are still expected to provide support to meet the challenges, but the short-term expectation of strong stimulus is still high.

In addition, the high dividend style that has led the way since the beginning of the year has also experienced a significant correction in recent periods, which has once again sparked discussions in the market about whether the high dividend factor has "gone out". We believe that 1) The recent correction of seemingly high-dividend sectors cannot necessarily be attributed to dividend factors themselves, but is more related to industry factors; 2) After experiencing a large increase in high-dividend factors, it is normal for some retracements to occur due to rotation, which suggests that caution should be exercised when the dividend yield is lower than 4% (Hong Kong stocks are lower than 5%); 3) When screening for high dividends, it is necessary to focus on profitability and dividend capabilities rather than simple high or low dividend yields. Therefore, targets that have stable profitability and strong dividend capabilities provide better layout opportunities in recent fluctuations.

Since the peak at the end of May, the Hong Kong stock market has fallen nearly 10%. Since mid-May, we have been reminding investors that this round of rebound is mainly driven by the funding side and emotions. Therefore, with the market entering the overbought range, investors' divergences and profit-taking are not surprising. Assuming that the risk premium is fully restored to the level of the high point at the beginning of 2023, the corresponding target index level of the first stage of the Hang Seng Index is 19,000-20,000 points (see May 12th "The market is approaching our first stage target" and May 26th "not surprisingly taking profits"). In the past few weeks, overseas funds, especially value-oriented active foreign funds, have flowed out again. The outflow scale this week has increased from USD 93.24 million last week to USD 340 million. This can also provide proof ("Active Foreign Funds Maintain Weakness"). However, with the recent continuous decline of the market, especially A shares falling below 3,000 points again, concerns about the Hong Kong stock market falling to the previous low are also increasing. In this regard, we are not so worried, although we have always believed that further upward momentum needs more catalysts to start, it will not completely give up all the gains, and the Hang Seng Index around 18,000 points can get some support, and looking back at this week's market performance also confirms our previous judgment ("temporary pause or end of rebound"). In addition, compared with A shares, which have returned all gains since March, the Hong Kong stock market has shown obvious resilience, which is consistent with our judgment that the Hong Kong stock market is better than A shares ("The Hong Kong stock market still has a comparative advantage").

In the previous week, driven by the expectation of a rate cut by the Fed, the Hong Kong stock market rebounded, and the Hang Seng Index returned to 18,000 points. However, this rebound didn’t last long. Over the past week, especially on Friday, there was a significant retreat. The Hang Seng Index once again fell below the 18,000 points level, and is currently close to the 120-day moving average support level. Correspondingly, investor sentiment is more depressed, and the proportion of short-selling transactions has risen rapidly from the previous low of 12.9% to a relatively high level of 18.5%. On the capital side, overseas funds continued to weaken, northbound funds flowed out nearly 20 billion yuan within the week, and EPFR data showed that foreign capital outflows have also accelerated. As the index weakens, some high dividend sectors, such as energy and raw materials which have led the way since the beginning of the year, have also experienced significant corrections, which has also attracted investors' attention. Not only that, gold and the U.S. Russell 2000 index, which should benefit from the "rate cut trade," also experienced significant corrections last week. Investors can't help but wonder why Hong Kong stocks and the above assets not only didn't benefit from the expected rate cut, but instead experienced significant declines, in the absence of significant changes in the expected CME futures rate cut (the probability of a rate cut in September is still as high as 94%).

In fact, the global assets and Hong Kong stocks' response to the "rate cut trade" last week was not unexpected in a sense, and it is consistent with our judgment in the "Rate Cut Trading Manual" and "Hong Kong Stocks in the Interest Rate Cut Cycle." On the one hand, this round of interest rate cuts has been short and the market has jumped the gun, so when the rate cuts are realized, it may be close to the end of the trading. The easing policy has already passed halftime. On the other hand, the impact of interest rate cuts on the Chinese market is indirect and secondary, and domestic factors will play a greater role. Specifically,

►The "rate cut trade" will initially play a role through the denominator end, so those assets that are sensitive to liquidity, especially those that have lagged behind in the early stage, have greater elasticity in the initial period. For example, the biotechnology and semiconductor sectors of U.S. Russell 2000 and Hong Kong stocks, which have longer durations, are so, and the changes in the denominator are more sensitive, which is also earlier manifested in the performance of the sectors. However, due to the particularity of this rate cut cycle, the rate cut cycle is shorter and there are fewer, plus the market has jumped the gun, which may cause overdrawn and fallback even before the rate cut is realized. This partially explains the high and then fall-back of the gold, precious metals sectors, and the Russell 2000 ("Rate Cut Trading Manual").

The 'Trump Trade' has affected the performance of some sectors. Market attention has increased over its policy stance due to the rapid rise in Trump's approval rating. Recently, the decline in the US stock market's semiconductor, electric vehicle sectors, and international oil prices is related to its statements that may impose tariffs on trade, significantly increase oil production, and terminate current electric vehicle policies if elected. In addition to the above-mentioned sectors mapped to the Hong Kong stock market, the uncertainty of imposing tariffs may also affect investor sentiment.

However, external factors are ultimately indirect and secondary. As emphasized in "HK stock market in interest rate cut cycle", the internal environment is the key to determining the direction of the Hong Kong stock market. Although the US bond interest rate fell sharply at the end of last year, the Hong Kong stock market still fell; when the US Federal Reserve began to cut interest rates from July to September 2019, the Hong Kong stock market continued to fluctuate, and active funds from overseas continued to flow in, which is evidence. From this perspective, the recent data fatigue and the uncertainty of the subsequent policy direction may be more important factors that are dragging down the market performance. In the second quarter, GDP YoY was 4.7%, which was lower than the market expected 5.1% and the first quarter's 5.3%. Among them, exports continue to show resilience, but the slowdown in domestic demand has led to a weak total demand. The net export contributed 13.9% to the economic growth in the first half of the year, and the strong foreign demand also drove the increase in industrial added value and manufacturing investment. In June, industrial added value YoY was 5.3%, which was slightly lower than the MoM increase of 5.6% in May. Manufacturing investment from January to June also maintained a high growth rate, with a YoY increase of 9.5% (9.6% YoY in January to May). However, in contrast to foreign demand, affected by autos and online retail, social zero growth YoY fell rapidly from 3.7% in May to 2% in June. Although real estate sales have improved somewhat, investment remains weak. This reflects the inadequacy of residents' consumption capacity and willingness, coupled with the pre-positioning of foreign demand in the first half of the year, as well as the uncertainty that may arise for exports after the election due to possible changes in trade policies. This still indicates the necessity of fiscal measures to hedge against the weak or even shrinking credit cycle of the private sector to boost internal demand.

Against this background, the Third Plenum held this week has aroused widespread attention, but its focus is more on long-term reform direction rather than short-term stimulus. This explains the market's expectation of the policy direction remains unclear in the future. The Third Plenum, as an important meeting to formulate a guiding document and the overall development plan of the domestic economy in the future, usually involves medium- to long-term development goals rather than short-term specific policies. Overall, the main content of this Third Plenum is the same as that of the 19th National Congress. It basically meets market expectations. We summarize the key points and changes that are worth focusing on: 1) emphasize medium- to long-term growth quality and weaken short-term absolute speed. The conference regards "high-quality development" as the "primary task" of building a socialist modern country in an all-round way, showing the country's emphasis on the quality of medium- to long-term economic growth, and weakening the demand for short-term absolute speed. 2) Emphasize high quality and high-level safe development, weaken short-term pursuit of intensity and total quantity. In the high-quality development process, the meeting also reflects the emphasis on the quality and safety of development in the new development stage, such as "establishing a new system and mechanism for developing new quality productive forces that are suitable for local conditions," and "realizing the benign interaction of high-quality development and high-level safety." 3) Emphasize fair distribution of factors and weaken market dominance. In terms of economic system construction, this meeting has a greater emphasis on promoting the complementary advantages and fair participation of various ownership economies in the market competition, but at the same time, it proposes to "let the market be more active" and "manage it well," which may enhance the role of the government in maintaining market order and compensating for market failures in the future.

However, this Third Plenum, which is rare in analyzing the current situation and tasks (the first two were respectively in 1998 and 2008), emphasizes the achievement of the annual economic and social development goals and also mentions issues such as real estate and local debt. Therefore, we believe that in the face of complex domestic and external environments, policies may still provide support to cope with various challenges in the short-term, but the threshold for strong short-term stimulus is still high. Subsequently, the specific decisions of the conference and the deployment of short-term policies at the July Political Bureau meeting are worth special attention.

In addition, the high-dividend style that has led this year has also recently undergone a significant correction, once again triggering a discussion on whether the dividend factor has been "extinguished". We believe that 1) the recent correction of seemingly high-dividend sectors may not necessarily be attributed to dividend factors themselves, but more related to industry factors. For example, fluctuations in the energy and raw materials sectors affected by the 'Trump transaction'. However, A-share and Hong Kong stock high-dividend symbols overlap more with energy and raw material sectors. Therefore, it is too simplistic to attribute their fluctuations to dividend factors. 2) After experiencing a large increase, the high dividend factor's pullback due to rotation is also a normal situation, which does not change the logic of long-term investment. Considering that the current 10-year bond interest rate is around 2.3%, plus certain risk compensation, we suggest caution when the dividend yield is below 4% (below 5% in the Hong Kong stock market), and wait until the rebound is sufficient before re-entering. 3) However, short-term fluctuations do not change the long-term investment logic determined by the macro environment. Under the background of no significant opening of the credit cycle and downgrading of long-term growth expectations, the dividend factors of providing stable returns to counter the decline of the long-term return rate still have investment value, unless the government makes a large fiscal effort. However, recent fluctuations also illustrate, as we have always warned, that when screening high dividends, it is necessary to focus on profit and dividend capabilities, rather than simply on high or low dividend yields. Therefore, targets with stable profits and strong subsequent dividend capabilities provide better layout opportunities in recent market fluctuations.

In summary, under the benchmark scenario, we believe that expecting strong stimuli is still unrealistic. Internal and external constraints make it difficult for policies to be presented in a "comprehensive" manner. In this situation, compared to exponential market trends, the market is more likely to maintain structural trends under a volatile pattern. In terms of allocation, under short-term overseas interest rate cuts, growth sectors benefited from denominator logic may have higher elasticity, such as semiconductors, autos (including new energy), media entertainment, software, biotechnology, etc. Conversely, high dividends may lag behind in this phase, but this does not change the overall allocation pattern. Overall, we continue the allocation logic in our outlook for the second half of the year, recommending three directions under structural trends: overall downside (high dividends and high repurchases with stable returns, that is, "cash cows" with ample cash flow), local leverage (especially related to new productive forces supported by the third plenary session policy and still viable technology growth), and local price increases (natural monopoly sectors, upstream and public utilities).