Source:Internet-Magician Gang

Author: Leader of the Phantom Thief Team Pei Pei; The author of this article may hold the financial assets mentioned in the article and attempt to profit from active trading. Readers should be fully aware of the potential conflicts of interest that may exist.

During the National Day holiday, the Hang Seng Index, the Hang Seng Tech Index, and the Nasdaq Golden Dragon Index rose by 9%, 13%, and 12% respectively (Note: as of 12:00 on October 7 Beijing time); this is enough to make A-share investors who are on holiday lament. Due to the absence of the limit-up and limit-down system, coupled with the free inflow and outflow of international capital, once the Hong Kong and Chinese concept stock markets enter a bull frenzy, their momentum is far more fierce than A-shares. In just two weeks, the Hong Kong stock market has become one of the best-performing capital markets globally this year.

Foreign investment banks are turning bullish: I believe everyone has seen the recent report from Goldman Sachs, which believes that the MSCI Chinese Index (mainly representing Hong Kong and Chinese concept stocks) and the CSI 300 Index (representing A-shares) still have 15-18% upside potential. Leaving A-shares aside for now, I have discussed them in a previous article; today I will mainly discuss the issues related to Hong Kong stocks and Chinese concept stocks.In a previous article before the holidayI have already discussed; today I will primarily discuss the issues related to Hong Kong stocks and Chinese concept stocks. From a fundamental perspective, everyone is waiting for clear signs of the Chinese economy's recovery, especially in the real estate market. If the real estate market immediately recovers, the wealth effect generated will help in the recovery of consumption, which will eventually spill over into the job market, fundamentally driving the wheels of the real economy forward. However, this process will take at least a few months, and the transmission process is bound to be complex and winding.

From a market perspective, the biggest suspense for Hong Kong stocks and Chinese concept stocks is: when will foreign institutional long-only funds enter the market in a big way? Or, have they already entered on a large scale? This will determine the fate of the market not just for a few months, but for several years to come.

Before the start of this round of rebound, foreign institutional funds' allocation of Chinese assets (including Hong Kong stocks, A-shares, and Chinese concept stocks) was at the lowest level in nearly a decade. Goldman Sachs believes that the China allocation levels of global active funds (mainly public funds) are only 5%, compared to 15% four years ago; Merrill Lynch's statistics show that since the third quarter of this year, most of the time, foreign public funds have been reducing their holdings of Hong Kong stocks while hedge funds have been consistently short selling Hong Kong stocks. In fact, even without referring to statistics, just by taking a walk in Central and West Kowloon in Hong Kong, we can personally feel the gloomy atmosphere of the Hong Kong stock market. Especially when the stock markets in the US, Japan, and even India are performing well, foreign institutions that engage in global asset allocations can imagine the interest in Hong Kong stocks.

An overly tight spring is bound to rebound. However, this round of rebound is too rapid to be led by foreign public funds - because they adjust their positions slowly, have a lower speculative tendency, and cannot play a role in extreme ups and downs. From data from the Hong Kong Stock Exchange, the short covering led by hedge funds may have played a crucial role: in the second half of September, the short selling turnover ratio of Hong Kong stocks stayed above 18% for a long time, even breaking 20% several times, reaching historically high levels; however, by September 30, the short selling ratio plummeted to 13%, and the short selling ratio of Hang Seng Index constituent stocks even dropped to 10%. Regarding individual stocks, taking Tencent as an example, the daily short sell volume dropped from 7.08 million shares on September 27 to 2.86 million shares on September 30, and further decreased to 2.3 million shares on October 4. Many popular Hong Kong stocks have undergone similar dramatic changes.

We have reason to believe that overseas speculative funds, represented by hedge funds, are not only covering their short positions in Hong Kong stocks but also establishing long positions. During the National Day holiday, among the brokers with the highest trading volume on the Hong Kong Stock Exchange, names of American quant self-trading institutions such as Jump Street and Jane Street have appeared more than once, just a microcosm of overseas quant funds rushing into the Hong Kong stock market. Overseas speculative funds combined with mainland speculative funds have jointly created the dramatic turnaround of the Hong Kong stock market in the past two weeks. However, to further advance from the current situation, it is necessary to rely on the power of foreign public funds - if these long-term fundamental investors do not enter the market, the rebound cannot evolve into a reversal.

The issue is that the ultra-low allocation of foreign public funds to Hong Kong stocks and Chinese concept stocks did not happen overnight. Although since August 2020, their percentage of Chinese assets holdings has been on a long-term decline, there are two time points that are exceptions:

• In the second half of 2021, considering the better-than-expected performance of the Chinese economy, especially in exports, and the signs of recovery in offline consumption, foreign public funds increased their allocation to Chinese assets to a certain extent. At that time, the Hong Kong and Chinese concept stock indices seemed to be in a "repeatedly bottoming out waiting for a reversal" situation. As for what happened next, I don't need to say much.

• From the end of 2022 to the beginning of 2023, the comprehensive opening-up led to a significant improvement in market sentiment, with "long China stocks" temporarily becoming one of Wall Street's "most crowded trade strategies"; foreign public funds, like hedge funds, also entered the market. However, due to the impact of events and an overall economic recovery slower than expected, this reversal lasted only three months before coming to an end.

In other words, within just three years, foreign public funds have already experienced at least two "false confidence reversals"; some have even experienced a third one, which is the rebound of Hong Kong stocks and Chinese concept stocks in the second quarter of this year, which also ended prematurely due to an economic recovery slower than expected. As the saying goes, "things come in threes." After experiencing this cycle of "hope and disappointment" multiple times, igniting their confidence again will certainly be more challenging. Hedge funds can go long and short at the first opportunity to save the market, as their investment timeframe is shorter and their portfolio adjustments are more flexible; public funds with longer assessment periods and heavier positions cannot do this.

During the National Day holiday, I had private discussions with some foreign institutional investors, and the feedback I received was that most people are still taking a wait-and-see approach. One friend's statement was particularly classic: "If this is a real reversal, then there is still a lot of upside potential, and every pullback in the next six months is an opportunity to enter the market. If this is not a real reversal, then it is already too late to enter now."

From a purely valuation perspective, the current Hong Kong stocks and Chinese concept stocks are very cheap, with the 'quality assets' (such as my favorite internet companies) being particularly inexpensive, and this point goes without saying. However, we must not forget that since the end of 2021, these assets have been very cheap. The reason we consider them cheap is because we have confidence in China's long-term economic growth; foreign investors who have lost confidence will not consider them cheap. 'Illness comes as swiftly as a mountain falls, and it goes away like the pulling of threads.' The process of regaining confidence is bound to be lengthy, and different types of investors will regain confidence at different times.

So, can the current Hong Kong stock market continue without the participation of foreign public funds? Exactly three years ago, I asked friends from the Hong Kong Stock Exchange and Hong Kong Chinese securities firms this question. At that time, they were very optimistic: 'Many popular Hong Kong IPO subscriptions rely entirely on Chinese institutions, so it's not so scary if foreign funds do not participate!' However, the subsequent three years of history have proven this optimism wrong. As an internationally free financial hub with free capital flow, the attractiveness of Hong Kong's capital markets primarily comes from internationalization, followed by the support of mainland China. We must not reverse this order.

However, if the post-holiday A-share market continues (at least without a rapid end), it is indeed possible to generate a certain 'overflow effect,' thereby allowing Hong Kong stocks to maintain an upward trend for a period of time with the support of mainland funds. The specific logic may be as follows:

• The A-share market surge has brought about a huge wealth effect, and some investors who have made money are turning their attention to the more attractive valuation of Hong Kong stocks, making certain adjustments to their positions (regardless of whether through the Hong Kong Stock Connect).

• Some of the mainland bank credit funds may flow into the stock market, although this is against the rules, it cannot be completely eliminated; some of it may spill over into Hong Kong stocks through various means.

• Do not forget, in the last five trading days before the holiday, the net inflow of Southbound funds through the Hong Kong Stock Connect was only 6.1 billion, and on September 30th, it was only 12.1 billion. In theory, the post-holiday Southbound funds can have a much larger impact on the Hong Kong stock market.

It should be noted that even if the above assumptions come true, this Hong Kong stock 'bull market' led by mainland speculative funds is bound not to last long. To achieve a sustained, fundamental, fundamentally driven bull market, foreign public funds must significantly increase their holdings of Chinese assets. Whether these funds participate is not important for the A-share market, but it is very important for the Hong Kong stock market. Besides economic data, what can prompt them to change their attitude and regain confidence are statements from regulatory authorities on future economic development strategies. Therefore, the post-holiday press conferences held intensively by all levels of regulatory authorities are important to everyone, as the eyes of the world are closely watching.

Of course, I hope this is a genuine and long-term bottom reversal because such a reversal would be beneficial to all of us. But good wishes may not necessarily equate to reality, and everything is still an unknown.

Editor/Emily