Last week was a crucial window period for domestic policy, and the market fluctuated significantly under the influence of expectations. Although it ultimately closed higher, the overall performance was not satisfactory compared to the previously strong policy expectations. So, is the market's expectation excessive, or does the policy still need to make further efforts?

Three weeks ago, it was emphasized that there are generally three 'expectation gaps' in the current market, the most significant of which is the expectation regarding the intensity and speed of domestic stimulus. Since September 24, we have been able to see a marginal shift in policy stance. However, both A-shares and Hong Kong stocks have already shown significant reactions, so expecting the market to move 'further' will clearly require more incremental policy support, rather than just the policies that are already fully factored in by current market expectations. Moreover, foreign capital has even greater expectations regarding incremental policies and stimulus direction.

So how should the strength of this policy be understood? First, the policy does convey a different set of Bullish Signals compared to the past. However, after the market fully digests the expectations, there is still an anticipation for more concrete implementation of scale. Additionally, the central economic work conference provided limited incremental information on certain market concerns (such as fiscal stimulus intensity, consumer subsidies, etc.), and some expressions, such as 'strengthening regulation' on platform economy, have even led to adjustments in market expectations. This may fall short of expectations for some investors, especially overseas funds.

In the overseas environment, next week the December FOMC meeting of the Federal Reserve is approaching. The expectation of interest rate cuts may warm up and possibly reduce disturbances, but the market is more focused on subsequent paths and tariff impacts.

On the allocation level, under the assumption that domestic policy intensity is mild and limited, the current volatile structure remains the baseline scenario. If there are significant fluctuations caused by disturbances such as tariffs, it may actually provide better buying opportunities.

Market outlook

This week, the market fluctuated significantly. Although it ultimately closed higher, the overall performance was disappointing compared to the stronger policy expectations prior. At the beginning of the week, the Politburo meeting set a positive tone, and some statements exceeded market expectations, leading the Hang Seng Index to surge by 2.8% in a single day. However, after expectations were digested, sentiment cooled, and on Friday, after the economic work conference, the market fell by 2%, effectively erasing all gains made in the first half of the week.

This point can be seen fromtechnical indicatorsIt can also be verified: 1) The proportion of short sell transactions in the five days dropped to 13.7% after a significant market rally on Monday, basically returning to the level in early November, but it rose to 15.5% on Friday, slightly up from last week; 2) The 14-day relative strength indicator (RSI) surged to 59.9 after a big rally on Monday, a new high since mid-October, but then fell back to 50.9 on Friday. The recent market trend once again confirms our previous view, under the assumption of limited domestic policy strength, the current oscillation structure remains the baseline scenario, with the short-term market stagnant in this position, capable of going up or down. Compared to the A-shares, the weaker performance of the Hong Kong stocks also reflects the more subdued expectations from foreign capital. This week, proactive capital outflow expanded again, and the shift of passive capital to outflow also supports this point.

Chart: The short sell transaction ratio in Hong Kong stocks slightly rose to 15.9%

Data Source: Bloomberg, China International Capital Corporation Research Department.

Chart: The Hang Seng Index's 14-day RSI slightly fell to 50.9

Data Source: Bloomberg, China International Capital Corporation Research Department.

So, is it the case that market expectations are excessive, or does policy still need to exert more effort?

Currently, there are three common "expectation gaps" in the market, with the most significant one being expectations regarding the intensity and speed of domestic stimulus. Since September 24, we have indeed seen a marginal shift in policy stance, but both A-shares and Hong Kong stocks have already responded significantly, having rebounded sharply from the bottom. Therefore, anticipating a "further step" from the market clearly requires more incremental policies to support it, rather than merely relying on the policies already fully factored into current market expectations. Moreover, foreign capital is also more eager for incremental policies and stimulus directions. From this perspective, the market indeed desires "more," which is reflected in various indicators including risk premium (ERP). At present, the expected ERP has basically reached the level of early May (7.2%), so on this basis, the market clearly needs stronger policies than before to achieve further performance.

Chart: The risk premium of the Hang Seng Index rapidly declined from 7.55% to 7.21%.

Source: Wind, China International Capital Corporation Research Department.

So how should the intensity of this policy be understood? First, the policy indeed conveys positively different signals from before. At the beginning of the week, the Politburo meeting first mentioned "extraordinary counter-cyclical adjustment," proposed "moderate easing" of monetary policy again after more than a decade, emphasized "more positive and proactive macro policies," and provided guidance on "stabilizing the real estate and stock markets," all of which significantly exceeded market expectations and led to a substantial market surge. However, after the market has fully digested these expectations, there is still hope for more concrete implementation. Additionally, the Central Economic Work Conference provided limited incremental information on certain market concerns (such as the intensity of fiscal stimulus, consumption subsidies, etc.), and even some wording, like "strengthening regulation of the platform economy," has triggered adjustments in market expectations, which may not meet expectations for some investors, especially overseas capital.

Furthermore, the economic data for November shows that the fundamentals still require further policy support. 1) In terms of prices, the recent price changes are still showing a divergence trend. In November, the CPI year-on-year slightly decreased from 0.3% to 0.2%, while the core CPI slightly increased year-on-year to 0.3%, with food prices marginally dragging down by nearly 0.3 percentage points. The impact of the old-for-new policy has led to improvements in the prices of home appliances, Autos, and electronics. The PPI year-on-year decline increased slightly from -2.9% to -2.5%, marking the first positive month-on-month change since May. 2) In terms of exports, following the previous "export forward" effect, November's export growth year-on-year was 6.7%, below expectations (8.7%) and last month's figure (+12.7%). 3) In financial data, the narrowing decline in M1 for November indicates that the results of government debt reduction are beginning to show, but the growth rates of new social financing, RMB loans, and M2 are all below market expectations. The decline in M1 shrank to 3.7%, benefitting in part from local debt replacement improving government cash flow, indicating that debt reduction has a clear effect on liquidity enhancement. On the other hand, the year-on-year growth rate of M2 fell back to 7.1%, also showing that credit demand still awaits stimulation, aside from being influenced by the accelerated issuance of local government bonds leading to an increased fiscal deposit. Besides, the new social financing for November was 2.34 trillion yuan, a decrease of 119.7 billion yuan year-on-year, primarily due to a decline in enterprise loans, short-term loans for residents, and bill financing, indicating that financing demand in the real economy remains somewhat weak.

In the overseas environment, the FOMC meeting of the Federal Reserve in December is approaching next week. Expectations for interest rate cuts by the Federal Reserve are heating up, which may reduce disturbances, but the market is more concerned about the subsequent path and tariff impacts. The CPI in the USA for November rose but overall was in line with market expectations, with the parts exceeding expectations being fluctuations in oil prices and base effects that the market is not particularly worried about. In contrast, key service prices and rents have clearly withdrawn, which the market views as a positive signal. Currently, the implied expectation of an interest rate cut in December in CME has risen to 96% (Chart 7). Moreover, as Trump's inauguration approaches, we reiterate the potential path we projected two weeks ago and suggest that investors monitor several key nodes: After Trump's inauguration on January 20, he may quickly introduce some inflationary policies, including immigration and tariffs, at which point attention can be directed to his policy priorities. The State of the Union address and the new budget proposal in February-March will provide clearer directions for fiscal expenditure cuts.

Chart: The implied probability of a rate cut in December in CME has risen to 96%.

Source: Wind, China International Capital Corporation Research Department.

In terms of allocation, under the assumption of moderate and limited domestic policy efforts, the current oscillation structure still represents the benchmark scenario. If significant fluctuations arise from disturbances such as tariffs, it could instead provide better buying opportunities. Under the overall assumption of an oscillating pattern, we recommend focusing on three types of sectors: first, sectors with sufficient clearance of supply and policy environment; if marginal demand improves, it will yield better results, including parts of Consumer services like Internet Plus-Related, household appliances, textiles, and electronics. Second, focus on sectors supported by policies, such as household appliances and Autos under the trade-in policy, as well as the trends in the self-reliant technology fields like computers and Semiconductors; and third, sectors that provide stable returns, such as high-dividend state-owned enterprises.

Specifically, the main logic supporting our above viewpoint, as well as the changes to pay attention to this week, mainly include:

1) In November, China's CPI year-on-year fell to 0.2%, and the PPI year-on-year decline narrowed to 2.5%. In November 2024, China's CPI year-on-year dropped from 0.3% in October to 0.2%, lower than Bloomberg's consensus expectation of 0.5%, and compared to October's -0.3% fell to -0.6%; core CPI year-on-year rebounded to 0.3%, slightly above the previous value of 0.2%, with a slight month-on-month decrease to -0.1%. Food prices were the main drag, while the trade-in policy improved consumer prices for household appliances, Autos, and electronics. The year-on-year decline in PPI narrowed from 2.9% in October to 2.5%, higher than Bloomberg's consensus expectation of -2.9%, and month-on-month recovered slightly from -0.1% in October to 0.1%.

2) China's November export year-on-year growth rate fell to 6.7%, and the import year-on-year growth rate further slowed to -3.9%. China's dollar-denominated export year-on-year growth rate decreased from 12.7% in October to 6.7%, lower than the consensus expectation of 8.5%; the year-on-year growth rate of imports slowed from -2.3% in October to -3.9%, also lower than the consensus expectation of 0.9%. The decline in exports was mainly due to the early 'rush to export' effect, while the widening decline in imports indicated that domestic demand remained weak and short-term factors could not be ruled out.

3) New Renminbi loans, new social financing, and M2 year-on-year growth rates in China fell short of market expectations in November, while M1 year-on-year growth rate exceeded market expectations. In November, new social financing was 2.34 trillion yuan, a year-on-year decrease of 119.7 billion yuan, slightly below the expected 2.59 trillion yuan; new Renminbi loans were 580 billion yuan, lower than the consensus expectation of 945 billion yuan, with a year-on-year decrease of 510 billion yuan. The year-on-year decline in M1 narrowed from 6.1% in October to 3.7%, higher than the consensus expectation of -5%; the year-on-year growth rate of M2 declined from 7.5% in October to 7.1%, while the month-on-month growth rate slowed from 1% in October to 0.5%.

4) In the USA, the CPI and core CPI in November both rose to 0.31%, basically in line with market expectations. The US CPI in November was 0.31% month-on-month, with a consensus expectation of 0.3%; year-on-year it was 2.75%, compared to a consensus expectation of 2.7%. Core CPI was 0.31% month-on-month, in line with the consensus expectation of 0.3%; year-on-year, it was 3.32%, also matching the consensus expectation of 3.3%. The month’s CPI increase was driven by a base effect in addition to a significant recovery in energy contributions, which was the main reason for the overall CPI rise; the increase in core CPI was mainly affected by clothing and new vehicle prices. Service inflation retreated significantly, driven by rent and transportation costs, decreasing month-on-month from last month's 0.35% to 0.28%.

4) Overseas active fund outflow expanded, and passive funds turned to outflow, while southern funds accelerated inflow. EPFR data shows that as of December 11, overseas active funds outflow from the overseas Chinese stock market expanded to 0.48 billion USD (compared to the previous week's outflow of 0.25 billion USD), marking nine consecutive weeks of outflow. Overseas passive funds saw a reversal to outflow of 0.21 billion USD (compared to the previous week's inflow of 0.21 billion USD). Meanwhile, southern capital inflow slightly accelerated from last week's inflow of 18.3 billion HKD to an inflow of 21.12 billion HKD.

Chart: Active foreign investment continues to experience Outflow, while passive foreign investment has turned to Outflow.

Source: EPFR, Wind, China International Capital Corporation Research Department

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