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First, the week of Hong Kong stocks: what is the impact of the rise of the Hong Kong dollar and the depreciation of the RMB on Hong Kong stocks?

This week, the world first rose and then suppressed. On April 29th, Gilead Sciences Inc announced that there were positive data for the study of RedSivir in the treatment of COVID-19, which once boosted market sentiment. But risk aversion rose again in the next two trading days, affected by weak US economic data and media revelations that the US was considering retaliatory measures against China. Hong Kong stocks had three trading days this week (4.27-4.29), with the Hang Seng Index and the Hang Seng China Enterprises Index up 3.41% and 3.98%, respectively. In terms of the plate, the Hang Seng first-level industry all rose, the comprehensive industry led the rise, and the increase in the health care industry was relatively small.

Recently, investors have paid more attention to exchange rate changes. Since March, the Hong Kong dollar exchange rate has continued to strengthen and repeatedly hit the strong convertibility guarantee line, while the offshore RMB exchange rate has been "depreciated" during the May Day holiday. What is the logic behind the appreciation of the Hong Kong dollar and the depreciation of the RMB? What is the impact of changes in the exchange rates of the Hong Kong dollar and RMB on the Hong Kong stock market? In this issue, we will conduct an in-depth analysis of this topic.

1.1 interest rate spreads between the United States and Hong Kong continued to fall, and arbitrage funds pushed up the exchange rate of the Hong Kong dollar

The exchange rate of the Hong Kong dollar touched the strong side's guarantee that the Hong Kong Monetary Authority intervened in the market.The current appreciation of the Hong Kong dollar began with the 19Q4 and began to approach the strong-side convertibility guarantee line 7.75 in late March 20. In the two weeks since April 21, the HKMA has repeatedly bought US dollars from the market as the Hong Kong dollar touched strong guarantees. It is also the first time that the strong-side convertibility undertaking has been triggered since October 2015.

The return of overseas capital to Hong Kong stocks partly boosted demand for the Hong Kong dollar.Judging from the inflow trend of overseas ETF funds linked to Hong Kong stocks, overseas funds turned to net purchases in April after a large net outflow in March. However, due to the relatively low amount of overseas capital returning to Hong Kong stocks, equity investment is not sufficient to fully explain the increase in demand for the Hong Kong dollar.

The key factor causing the Hong Kong dollar to hit the strong side guarantee is that cross-border capital arbitrage has become active against the backdrop of lower Libor-Hibor spreads.The interest rate spread between the United States and Hong Kong is the main reference for the decision-making of cross-border capital carry trade. When Libor-Hibor spreads fall, it often causes arbitrage funds to buy Hong Kong dollars and short US dollars, and the Hong Kong dollar tends to appreciate against the US dollar. Libor-Hibor spreads have continued to decline since Q4 last year, with Hibor-Libor spreads exceeding 1 per cent in January in late April.

Why are Libor-Hibor spreads lower?First of all, the current liquidity situation is not "overseas loose, Hong Kong tight". In the context of "global easing", Libor and Hibor have declined significantly recently, but due to the Fed's implementation of "unlimited QE", the launch of a number of liquidity instruments and other factors, overseas US dollar liquidity is more abundant. Judging from the Fed's balance sheet, the total balance sheet of the Fed reached $6.7 trillion by the end of April, expanding by nearly $3,000bn in two months.

On the other hand, Hong Kong did not cut interest rates by the same magnitude as the United States in March, and the widening spread of benchmark interest rates can also explain the greater decline in Libor than in Hibor.

From the perspective of Libor pricing mechanism, Libor, as the US dollar lending rate, can be regarded as a substitute for the Fed interest rate, which is highly consistent with the Fed benchmark interest rate. Although the liquidity stampede led to a surge in Libor interest rates in March, Libor has recently fallen significantly and moved closer to the Fed's benchmark interest rate after the liquidity crisis was over.

Under the linked exchange rate system, Hong Kong's benchmark interest rate is pegged to the Fed's benchmark interest rate, but after the Fed cut interest rates by 100bp in March, the HKMA only cut the benchmark interest rate by 64bp to 0.86 per cent. This is because the Hong Kong benchmark interest rate pricing rules are the lower limit of the Fed's benchmark interest rate target range plus 50bp, or the average of the five-day moving average of overnight and one-month Hibor, whichever is the higher. Based on the data of the day when the Fed cut interest rates to zero on March 15, the two were 0.5 per cent and 0.86 per cent respectively, so Hong Kong's benchmark interest rate was set at 0.86 per cent. The difference in the cut in benchmark interest rates between the United States and Hong Kong also explains that the downside of Libor is greater than that of Hibor.

1.2 Sino-US bilateral relations are subject to renewed variables, and the RMB is facing depreciation pressure.

On May 1, US President Donald Trump said publicly that he was considering actions such as sanctions and tariffs against China. As a result, the offshore RMB exchange rate fell below 7.13 on May 1, down more than 500 basis points from the previous trading day.

From the perspective of fundamental factors, there is little pressure on the devaluation of the RMB.The spread of 10-year treasury bonds between China and the United States is the fundamental indicator to determine the strength of the RMB exchange rate. When the spread between China and the United States rises, capital inflows support the exchange rate of RMB. At present, the spread between China and the United States is close to 200bp, which belongs to a relatively safe range.

However, with reference to 19 years of experience, in addition to the fundamentals, changes in market risk appetite will also lead to the devaluation of the RMB.From May to August in 1919, the interest rate spread between China and the United States widened from the highest 80bp to 160bp, but during this period, the RMB exchange rate depreciated from 6.7 to more than "7". The main factors behind it are the twice escalation of Sino-US trade frictions, the decline of market risk appetite and the choice of cross-border capital outflows to avoid risks.

The possibility of renewed variables in Sino-US bilateral relations cannot be ruled out in the short term, and the RMB may once again face certain depreciation pressure because of the rising risk aversion in the market.

1.3 how will the rise of the Hong Kong dollar and the depreciation of the RMB affect the trend of Hong Kong stocks and industries?

There is no obvious pattern between the strength of the Hong Kong dollar and the trend of the Hang Seng Index.From the perspective of historical experience, during the appreciation of the Hong Kong dollar, a strong Hong Kong dollar has a certain catalysis to attract overseas capital inflows, but it does not necessarily lead to a rise in stock prices, which is reflected in the trend of Hong Kong stocks. The trend of the Hang Seng Index did not show an obvious rule during the strong Hong Kong dollar period.

Specifically, the Hong Kong dollar once touched the strong guarantee line in early 2006, during which the Hang Seng Index continued to rise; from the end of 2008 to 2009, the exchange rate of the Hong Kong dollar continued to be around 7.75, and the Hang Seng Index fell first and then rose, fluctuating greatly; in 13-15, the Hong Kong dollar was once again near the strong guarantee, and the Hang Seng Index rose first and then fell.

Compared with the Hong Kong dollar exchange rate, the change of RMB exchange rate has a more obvious impact on the trend of Hong Kong stocks. In the context of RMB depreciation, especially in the context of "fast depreciation", Hong Kong stocks often face the double pressure of capital outflow and profit revision.

First, during the "fast depreciation" of the renminbi, cross-border funds tend to flow out of the Hong Kong stock market to avoid risk.During the three rapid devaluations of RMB since 2015 (2015.08Mel 2017.01, 2018.04Mel 2018.11, 2019.05Mel 2019.09), the ETF of overseas linked Hong Kong stocks mostly showed net sales.

Second, the "fast depreciation" of the RMB may lead to the expected downward revision of the Hong Kong stock EPS.With reference to 19 years of experience, in May and August, when the RMB was "depreciating quickly", the consensus growth expectations of the Hang Seng Index EPS were significantly revised down because investors were worried about the depreciation of the exchange rate and "killing profits".

However, it is worth noting that compared with May and August last year, the room for devaluation of the renminbi is relatively small, and the negative effect on Hong Kong stocks is expected to be relatively limited. In addition, if the RMB changes from "fast depreciation" to "slow depreciation", or even from depreciation to appreciation, there may be "positive feedback" on the return of foreign capital and profit improvement in the Hong Kong stock market.

At the industry level, drawing lessons from the industry performance experience of previous RMB devaluation cycles, and combined with the background of the impact of the COVID-19 epidemic on overseas demand, it is expected that there may be relative gains in Hong Kong stocks' defensive weak cycle sectors:

During the previous devaluations of the RMB, Hong Kong stocksRetail of food and main products, insurance, medicine and biology, public utilities, telecommunications servicesWeak cyclical sectors have performed better; in addition, the devaluation of the renminbi has helped to increase exports, but in the context of the sharp drop in overseas demand due to the COVID-19 epidemic, the depreciation of the renminbi has limited benefits to the export-oriented export industry.

1.4 Investment strategy: Hong Kong stocks are dragged down by the devaluation of the RMB in the short term, and the medium-and long-term value is still high.

We have analyzed the reasons for the recent appreciation of the Hong Kong dollar and the devaluation of the RMB, as well as the impact of exchange rate changes on Hong Kong stocks and industries. The conclusions are as follows:

The return of overseas capital to Hong Kong stocks partly boosted demand for the Hong Kong dollar, but the key factor causing the Hong Kong dollar to hit the strong side guarantee was that cross-border arbitrage activity became active after the US-Hong Kong interest margin fell. Libor-Hibor spreads have continued to decline recently, with Hibor-Libor spreads exceeding 1 per cent in January in late April.

Libor-Hibor spreads fell not because of liquidity "overseas loose, Hong Kong tight", recent Libor, Hibor are significantly downward, but due to the Fed's implementation of "unlimited QE" and other factors, overseas US dollar liquidity is more abundant. On the other hand, Hong Kong did not cut interest rates by the same magnitude as the United States in March, and the widening spread of benchmark interest rates can also explain the greater decline in Libor than in Hibor.

The devaluation of the renminbi is influenced by Trump's comments on sanctions against China. On May 1, US President Donald Trump said he was considering sanctions and tariffs against China. Although the interest rate spread between China and the United States is close to 200bp, which belongs to a relatively safe range, due to the possibility of regenerative variables in Sino-US bilateral relations in the short term, cross-border funds may choose to escape from risk, the RMB may face certain depreciation pressure.

Judging from the impact on the trend of Hong Kong stocks, the appreciation of the Hong Kong dollar has a certain catalysis to attract overseas capital inflows, but it does not necessarily lead to a rise in stock prices, and the strength of the Hong Kong dollar has no obvious regularity with the trend of the Hang Seng Index. However, the devaluation of the RMB, especially in the context of "fast depreciation", Hong Kong stocks often face the double pressure of capital outflow and profit revision. The good thing, however, is that there is relatively less room for RMB depreciation than in May and August last year, and the negative impact on Hong Kong stocks is expected to be relatively limited.

At the industry level, drawing on the industry performance experience of previous RMB depreciation cycles, and combined with the background of the impact of the COVID-19 epidemic on overseas demand, Hong Kong stocks are expected to perform better in weak cycle sectors such as retail, insurance, pharmaceutical and biological products, public utilities and telecommunications services.

Investment strategy: Hong Kong stocks are dragged down by the devaluation of the RMB in the short term, and the medium-and long-term value is still high.Short-term US stocks may fluctuate as a result of the downward revision of performance, which will have a negative impact on the emotional and capital side of the Hong Kong stock market. However, in the medium and long term, the advantages of low profit expectations and extremely low valuations of Chinese capital stocks in Hong Kong stocks, coupled with the "immunity" to debt risk, enhance the independence of Hong Kong stocks under future market fluctuations.

Industry configuration continues to focus on the three main lines of "low valuation, low volatility and scarcity":(1) for long-term funds, the high dividend of Hong Kong stocks is an excellent allocation direction (banks, real estate); (2) considering that the drag of the epidemic on fundamentals is beginning to be reflected, the necessary consumption "huddling" effect of "low sensitivity" of the epidemic is expected to continue. (3) the holding of high-quality "scarce assets" of Hong Kong stocks is a long-term constant theme, especially the high-quality and scarce Chinese capital stocks related to the mainland economy, which are concentrated in the "new economy" areas such as property services, software, Internet, medicine, and so on.

Market overview and sentiment tracking:This week (4.27-5.1) the Hang Seng Index rose 3.41%. In the sector, all Hang Seng first-tier industries rose, led by Comprehensive Industry, and the health care industry rose relatively little. The HVIX index and the proportion of put and call options on Hong Kong stocks fell slightly, while the proportion of short selling on the main board rose slightly.

Macro liquidity and valuation tracking:This week, the offshore RMB depreciated significantly against the dollar, with interest rates on 10-year US bonds of 0.64% and the spread between China and the United States (190BP). The price of WTI crude rose sharply to $19.80 a barrel. The Hang Seng Index PE is 9.78 times lower than the historical average.

Consistent expectation EPS tracking:This week, Bloomberg lowered its 20-year EPS growth forecast for the Hang Seng Index and the Hang Seng China Enterprises Index.

Go south and go north to track funds:This week, the net inflow of northbound capital was 4.98 billion yuan, while that of southward capital was 760 million yuan. The proportion of southward capital participation in Hong Kong stock turnover increased slightly.

II. One-week liquidity, earnings expectations and valuation of Hong Kong stocks

2.1 Market Overview and sentiment tracking

2.2 Macro liquidity and valuation tracking

2.3 consistent expectation EPS tracking

2.4 going south and going north to track funds

Risk hint

The risk of a sharp rise in dollar index and US bond yields

The risk of continued tightening of domestic credit policy

The risk that the economy and listed companies' profits fall short of expectations

The risk of the continued deterioration of the Sino-US trade pattern