We believe that the Hong Kong stock market is expected to be systematically revalued in 2021 to achieve better performance. The main logic includes:

First, Hong Kong stocks with medium and low valuations in the economic recovery are expected to perform better.The industry distribution of the Hong Kong stock market shows two major characteristics, that is, the proportion of technology stocks and traditional industries is large, and the valuations of companies in traditional industries are very low. In the logic of trading recovery, Hong Kong stocks that are undervalued and pro-cyclical are expected to achieve better yield performance, which has already occurred in the recovery in 2016 and 2017.

Second, the appreciation of the RMB exchange rate, Hong Kong stock valuation discount is expected to repair.After the opening of the Shanghai-Hong Kong Stock Connect in 2014, the valuation premium of A shares over H shares has continued to expand instead of narrowing. We believe that an important reason behind this is the expected devaluation of the RMB exchange rate. As the RMB exchange rate continues to appreciate and depreciation expectations fade after 2020, we expect the valuation discount of Hong Kong stocks to be substantially repaired.

Third, and most importantly, the southward capital continues to increase, and the pricing power of Hong Kong stocks will shift from foreign capital to domestic capital in the future.Net inflows of southward capital reached HK $135.7 billion in the first half of January, compared with HK $24.3 billion in the same period last year. The huge amount of southward funds reflects that domestic institutions are paying more and more attention to the Hong Kong stock market. At present, "the proportion of stocks invested in Hong Kong stocks does not exceed 50% of the fund's stock assets" has become the standard allocation of domestic fund products. In terms of the ability and scope of research on the Chinese economy and enterprises, domestic institutions will have more advantages. in addition to "big leading" companies, many "small and medium-sized leading" companies undervalued by Hong Kong stocks may also be valued by the market and revalued.

I. two major characteristics of the Hong Kong stock market

There are two major characteristics in the Hong Kong stock market, one is that the industry is distributed at both ends, that is, the market capitalization of technology stocks and traditional pro-cyclical companies is relatively large, and the other is that the valuations of companies in traditional industries are significantly lower.

The first feature of the Hong Kong stock market is that the value of the technology stock market is relatively large. Internet technology companies that we are very familiar with in our daily life, such as Meituan, Tencent, BABA, XIAOMI, and so on, are all listed on the Hong Kong stock market.

At present, the total market capitalization of listed companies on the Hong Kong stock market is about 47 trillion Hong Kong dollars. Judging from the market capitalization distribution of listed companies, technology stocks are undoubtedly the largest market capitalization weighting plate. Hong Kong technology stocks have a total market capitalization of HK $16 trillion, accounting for 34 per cent of the total market capitalization of Hong Kong stocks. If you consider that there are many biomedical companies in the Hong Kong stock market, then broad technology stocks can account for nearly 40 per cent of the total market capitalization of Hong Kong stocks.

In fact, as an important market for overseas listing and secondary listing of domestic Internet technology enterprises, Internet and technology companies constitute the core investment targets of the Hong Kong stock market.

In addition to technology, there are also many listed companies in traditional pro-cyclical industries in the Hong Kong stock market, mainly finance, real estate, and optional consumption, accounting for 17%, 11% and 13% of the market capitalization, respectively. The market capitalization of listed companies in the Hong Kong stock market is relatively small.

The second feature of the Hong Kong stock market is that valuations in traditional industries are very low. The valuations of companies in these traditional industries in the Hong Kong stock market are very low, one is that the absolute valuation is very low, and the other is that the valuation of the same company in the Hong Kong stock market is significantly lower than that of ah shares. As an example of brokerage valuations in the chart below, the average price-to-book ratio (PB) of Hong Kong-listed brokerages is only about 0.7 to 0.8 times, more than half of which are listed by the same company A shares listed in both places, and H-shares are valued significantly lower than A-shares.

From the international comparison, it can also be found that the valuation level of the Hang Seng Index is relatively low among the major market indices in the world.

Second, Hong Kong stocks with medium and low valuations in economic recovery are expected to achieve better performance.

The hang Seng index fell 3.4 per cent for the whole year in 2020, ranking very low among the world's major stock indices, lagging far behind the 27 per cent rise in the A-share CSI 300 index and the 16 per cent rise in the US S & P 500 index.

The main reason for this result is that traditional pro-cyclical industries, especially the financial sector, account for a large share of the market capitalization of the Hang Seng Index. As mentioned earlier, the industry distribution of the entire Hong Kong stock market is larger, with technology and pro-cyclical industries accounting for a larger share. Compared with the overall Hong Kong stock market, pro-cyclical industries account for a larger proportion of the market capitalization of the Hang Seng Index. In the Hang Seng Index, the market capitalization of listed companies in the financial industry is as high as 31%, optional consumer market capitalization accounts for 26%, and the market capitalization of the information technology industry accounts for only 22%.

The relatively large share of financial stocks is an important reason for the poor performance of the Hang Seng Index in 2020. in fact, the Hang Seng Technology Index rose as much as 79% in 2020, and its yield is much higher than that of the Hang Seng Index and the NASDAQ Index. This fully shows that although the Hong Kong market will be greatly affected by exchange rates and international events, the core force driving the performance of the Hong Kong stock market is still the fundamentals of the industry boom, which is no different from the A-share market or the US stock market. The price increase of the Hong Kong stock market is no less than that of other markets.

Looking forward to 2021, economic recovery will undoubtedly become an important investment main line of the market. According to the forecast of Guoxin Macro Group, in terms of actual economic growth, GDP growth will be around 2% in 2020 and GDP growth is expected to be around 9% in 2021; in terms of price level, CPI growth is expected to be 2.6% in 2020 and PPI growth is expected to be about-2.0%; CPI growth is expected to be about 1.5% and PPI growth is expected to be about 2.5% in 2021. This means that China's nominal economic growth may exceed 10% in 2021.

The rebound in nominal growth will bring the resilience of listed companies' fundamental profits. When the nominal growth rate rose to more than 10% in 2017, the growth rate of all A-share non-financial profits exceeded 30%. According to the profit forecast of Guoxin Strategy Group, the net profit growth rate of all A-shares of listed companies will rise to 16% in 2021, of which the profit growth rate of non-financial enterprises will rise to 24%, and the net profit growth rate of financial enterprises will reach 9%.

The traditional pro-cyclical industries in the Hong Kong stock market account for a large share of market capitalization and low valuation, which determines that it is possible to achieve better yield performance in the process of economic recovery. In retrospect, the last round of economic recovery was in 2016 and 2017, when all-A non-financial profits grew by more than 30 per cent. As can be seen from the stock price performance, the Hang Seng Index continued to outperform the Shanghai Composite Index in 2016 and 2017.

III. With the appreciation of RMB exchange rate, the discount of Hong Kong stock valuation is expected to be repaired.

The stock price premium and discount of AxiH has always been a hot issue in the market. The reasons for the differences in stock prices and valuations can be so different that two companies in the same industry can have different market valuations. However, the situation of Atroph is different, it is exactly the same company, the fundamentals are exactly the same, only listed on two different exchanges, the difference in Atroph's share price reflects more differences at the market level than differences at the company's fundamental level.

After the opening of the Shanghai-Hong Kong Stock Connect in 2014, the market had expected that with the opening and interconnection of the market, the stock price valuation difference between the two places would gradually eliminate and converge, and eventually achieve the same share price valuation of the same company. But that doesn't seem to be the case, and the gap in AbeliH's share price has widened rather than narrowed since 2014.

In the following table, we compare the A-share premium rate of AxiH Company at the end of June 2014 with the current A-share premium rate, where the A-share premium ratio is positive to indicate that A-share is more expensive than H-share, that is, Hong Kong stock discount, while a negative value indicates that A-share is cheaper than H-share, that is, Hong Kong stock premium. It can be seen from the results that at the end of June 2014, about 1/3 of A shares were at a premium for Hong Kong shares, with a median premium ratio of 16 per cent. But by January 2021, the current situation was that all A shares were discounted in Hong Kong, and the A-share premium rose sharply to 81 per cent.

Why is this? There may be many reasons behind it. However, we believe that the changing trend of the RMB exchange rate is an important reason.

Since H-share companies are mainland companies listed in Hong Kong, their share price valuations are characterized by "currency duality". On the one hand, their share prices are denominated in Hong Kong dollars, and the Hong Kong dollar is basically fixed against the US dollar. So its share price is highly linked to the US dollar. On the other hand, the financial data of H-share companies are denominated in RMB. This leads to the problem that the denominator exchange rates do not match when you calculate the valuations of these H-share companies.

We can make a case hypothesis and we can clearly see where the problem lies. Assuming that the current net profit of the premium company is 10 billion yuan and the exchange rate of RMB to Hong Kong dollars is 1.1, then the net profit is 11 billion Hong Kong dollars. If the price-to-earnings ratio is 10 times, then the corresponding market capitalization is 110 billion Hong Kong dollars. If other things remain the same now, if the RMB depreciates from 1 1.1 to 1:1, the net profit of the trade-in company will fall to HK $10 billion, and if the market capitalization remains the same, the price-to-earnings ratio will become 11 times.

In other words, the depreciation (appreciation) of the RMB corresponds to the larger (smaller) valuation of H shares. If there is a unilateral expectation of continuous depreciation (appreciation) of the exchange rate, H shares may have a larger valuation discount (larger premium). The valuation discount (premium) here definitely reflects the depreciation (appreciation) expectation of the RMB exchange rate.

Before 2014, the RMB exchange rate was basically expected to appreciate unilaterally, but since then, the RMB exchange rate has shown a strong depreciation trend and expectation. We believe that this may be one of the important reasons for the widening valuation discount of H shares. After 2020, with the proper control of the epidemic in China and the excessive easing of overseas currencies, the RMB exchange rate has appreciated sharply again, and the current expectation of a sustained depreciation of the RMB exchange rate has been eliminated. With the correction of exchange rate expectations, we expect that the valuation discount of H shares will be substantially repaired in the future.

IV. southward funds continue to increase, and the market pricing power is from the outside to the inside.

With the continuous rise of the overall valuation level of the A-share market, the value characteristics of the "valuation depression" of the Hong Kong stock market began to be favored by the market. After entering 2021, southbound funds continued to increase. According to our statistics, there was a net inflow of HK $135.7 billion in the half a month up to January 15, compared with HK $24.3 billion in the first half of January last year. In the first half of January this year, southward funds increased by 111.5 billion yuan compared with the same period last year, an increase of 458%.

Behind the rapid increase in capital going south, more and more institutional investors are beginning to expand the scope of investment in Hong Kong stocks. Since the beginning of this year, the vast majority of newly issued public offering fund products have raised the upper limit on the asset allocation ratio of Hong Kong stocks. "the proportion of Hong Kong stocks invested in stocks not exceeding 50% of the fund's stock assets" has become the standard choice for many actively managed fund products. In the future, the proportion of Hong Kong equity asset allocation of mainland public offering fund products can reach up to half, which means that there may be a huge amount of incremental capital for the Hong Kong stock market.

In the future, with the continuous increase of southward capital, we expect that the pricing power of the Hong Kong stock market may gradually shift from "foreign capital" to "domestic capital" in the near future. Compared with foreign-funded institutions, domestic-funded institutions will have more advantages in the research ability and coverage of Chinese economy and enterprises. therefore, in addition to the "big leading" companies, which already have extensive influence in the world, it is expected that more "small and medium-sized leading" companies in the Hong Kong stock market can be excavated by institutional investors in the future, so as to achieve value revaluation.