Market trend review

After digesting the earlier excitement, the market further returned to an disorderly consolidation state this week, with no clear clues in both overall trends and industry structures. At the index level, major indices fluctuated and closed lower, with the Hang Seng Technology leading the decline with a 1.4% drop. The Hang Seng China Enterprises Index, msci Chinese index, and Hang Seng Index fell by 1.2%, 1.1%, and 1.0% respectively.

At the sector level, information technology (+3.2%), consumer staples (+0.7%), and capital goods (+0.3%) led the gains, benefiting from relevant policy support, while media and entertainment (-2.7%), energy (-2.0%), and real estate (-1.8%) sectors posted significant declines.

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").

Following the sudden surge at the end of September, the pullback in the past two weeks has wiped out all the gains since October. This week, the market sentiment has stabilized somewhat, shifting towards a volatile market. As previously advised, we are not surprised by the recent pullback, as the optimistic expectations factored into the 22,500-point mark align closely with the highs seen at the beginning of 2023, indicating a need for stronger policies that have yet to materialize.

However, we also do not believe that the market will completely give back all the gains. It is more likely to consolidate and fluctuate at this level. After all, following the recent pullback, sentiment has essentially returned to a reasonable position, and the anticipated change in policy stance is a confirmed fact. Incremental policies are still expected to be introduced in the future. Currently, the Hang Seng Index's risk premium has risen to 7%, similar to the rebound peak level in May; the RSI has fallen from a high of 90.9 to the current 54.3, resembling the levels seen before the start of the recent uptrend in mid-September.

Currently, the market is in a certain 'weak balance' between expectations and policy implementation. Since the end of September, optimistic expectations for policy shifts have driven a significant market surge, but the policies have not been realized yet. At the same time, as the U.S. presidential election approaches, external disruptions are increasing, such as the recent rise in U.S. bond yields and the U.S. dollar, along with growing market concerns about tariffs.

► Trump is leading in both gambling odds and key swing state polls. According to RCP data, as of October 26, 2024, Trump and Harris are virtually tied in national polls (48.5%). 61% of gambling odds significantly favor Trump over Harris at 38%, and Trump is also leading Harris by 0.9% in key swing state polling.

► Recent overseas asset prices are trading based on the expectation of Trump's re-election: 1) U.S. bond yields rising rapidly; 2) U.S. dollar strengthening, while gold also hits new highs; 3) Vietnamese and Mexican exchange rates weakening due to potential damage from tariff policies, with the yuan also under pressure; 4) Bitcoin rising, new energy market lagging behind traditional energy, financial sector leading, and so on.

On one hand, the market expects large-scale policy efforts to provide new support, but at the same time, it is concerned about the impact of Trump's policies if he wins the election. The paradox lies in the fact that the two are mutually causal. In other words, under a 'stimulus-driven' policy response function, expecting significant policy stimulus precisely requires a greater external shock as a prerequisite.

We estimate that a significant increase in fiscal stimulus is needed to help address the core issue of the inverted relationship between investment return rates and financing costs faced by various sectors of the current economy. However, 'realistic constraints' mean that such a stimulus needs to be focused, making it unrealistic without external shocks.

If Trump is elected, the imposition of tariffs may significantly drag down overall exports and growth. Trump's tariff proposals mainly include: 1) 60% comprehensive tariffs on China; 2) up to 100% additional tariffs on specific industries (such as new energy). Looking back at the experience of the U.S. imposing tariffs on China in 2018-2019, the amount of goods imported from China on the tariff list saw a significant decrease after the imposition of tariffs. The inevitable 60% comprehensive tariff will undoubtedly hinder overall exports and GDP growth.

Exchange rates may serve as a hedging channel. Static analysis shows that if the RMB depreciates by 9% against the US dollar, it could offset the negative impact of the 60% tariff. During the 2018-2019 China-US trade friction, the RMB depreciated by over 10% against the US dollar and about 6% against a basket of currencies. However, this approach also faces multiple practical constraints, such as the possibility that the Fed's most aggressive easing phase may have passed, while Trump's competitive devaluation of the dollar proposition could also act as a constraint.

This also implies the necessity of fiscal stimulus to offset domestic demand. Broadly measuring fiscal deficit impulses, historical experience shows that when exports are weak, policies are strong, domestic demand provides downside protection against economic deceleration risks. Drawing lessons from the 2018 China-US trade friction, policy responses should be timelier and more forceful. We estimate that under the scenario of a 60% tariff increase, an additional 2.6 trillion yuan in fiscal deficit is needed to make up for the GDP drag caused by exports.

Based on the above reasons, the current market's 'indecisive' state is not difficult to understand. Looking at the movements of foreign funds over the past week further supports the cautious attitude: Passive fund inflows slowed down, halving from the previous week's base, indicating a further cooling of non-institutional investors' sentiment; Active fund outflows expanded, with this week's outflow led by long-term funds further increasing to 0.24 billion USD (compared to 0.19 billion USD outflow last week), confirming our previous suggestion that a significant return of long-term funds or an over-allocation would require more conditions and stronger expectations; Northbound funds accelerated inflows, with mainland banks and consumer sectors receiving the most inflows, while the previously leading diversified finance sector saw overall outflows.

Looking ahead, the 12th session of the National People's Congress Standing Committee is set to convene in Beijing from November 4-8, coinciding with the US election day (November 5). The market is highly concerned whether the forthcoming fiscal policy can provide the next catalyst for market performance. However, even if Trump wins, the specific timing and progress of tariff policy implementation still have significant uncertainties, so expecting a large-scale stimulus to immediately materialize remains unrealistic.

It is more likely that the conference will announce the scale of debt reduction mentioned in the fiscal department's press conference, followed by a focus on the year-end economic work conference setting the tone for next year's policies, as well as the specific arrangements for the budget and deficit in the two sessions next year, making the subsequent policy path of the US election clearer.

Therefore, we tend to see the Hong Kong stock market continuing to fluctuate at its current level, awaiting policy and election changes, with a focus on a structural market. Since the sentiment and fund situation in the Hong Kong stock market are more sensitive to overseas changes, the tariff policy may bring a greater short-term impact than in the A-share market. But we also believe there is no need to worry excessively:

Passive fund inflows slowed down, roughly halving from last week's level, indicating a further cooling of non-institutional investors' sentiment; Active fund outflows expanded, this week's outflows dominated by long-term funds further increased to 0.24 billion USD (compared to 0.19 billion USD outflows last week), confirming our earlier hints that significant inflows of long-term funds or even over-allocation will require more favorable conditions and stronger expectations; Southbound funds accelerated their inflows, with mainland banks and consumer sectors receiving the most inflows, while the previously leading diversified finance sector registered overall outflows.

On one hand, external pressure will bring "stimulus-style" policy stimulus, thereby promoting market repair and rebound; on the other hand, if there is no impact, it means there is no need to expect too much stimulus, and the market will mainly be dominated by the current volatile market, while the structural advantages of Hong Kong stocks make them more resilient.

At the industry level, considering that the current export chain is most affected by tariffs, and the current performance may not fully account for risks (companies with a high proportion of exports to the United States have not significantly underperformed), therefore, we recommend a short-term observation.

In contrast, we recommend focusing on the structural opportunities in Hong Kong stocks that have advantages, even in the face of market fluctuations, they are more resilient. Such as Hong Kong internet technology growth stocks, dividend assets may also benefit from market volatility and the implementation of new central bank exchange facilities as hedge. If subsequent policies continue to deliver, especially if fiscal measures exceed expectations, cyclically advantageous sectors are expected to outperform, including consumer, real estate chains, and non-banking finance, thereby driving greater room for overall index growth.

Specifically, the main logic that supports our above views and the changes that need to be focused on this week are mainly as follows:

1) The third quarterly earnings season has started, with some precious metals, overseas and export-related companies performing well. Last week, the third quarterly reports began to unfold, with some gold sector companies benefiting from the rise in gold prices, with Zhaojin Mining reporting a 141% year-on-year increase in net profit attributable to the parent in the first three quarters and Zijin Mining achieving a record high net profit in the third quarter.

In addition, some companies benefiting from overseas and export-related activities have also performed well, including Pop Mart, with overseas market revenue in the third quarter increasing by 440-445% year-on-year, continuing to thrive in Southeast Asia while further increasing contributions from the United States and Europe; at the same time, some marine transportation companies such as Cosco Shipping Holdings are also benefiting from the continuously strong global shipping market demand driving performance growth.

2) U.S. new home sales in September rose to 0.738 million households, hitting a new high since May 23. Last week, data from the U.S. Census Bureau showed that sales of new single-family homes in the U.S. rose by 4.1% in September 2023, seasonally adjusted to 738,000 units, the highest level since May 2023, exceeding market expectations of 720,000 units. We previously calculated that if trade conditions are not significantly disrupted by post-election policies, we expect this round of rate cuts to boost total export growth by 1.4%, contributing 0.35-0.4% to GDP growth.

We estimate that rate cuts could boost U.S. existing home sales by 2-4% to 4-4.1 million units (August existing home sales of 3.86 million units, pre-pandemic normal average level of 5.21 million units), business investments by 2-3%, thereby improving exports of capital goods and post-cyclical consumer goods by 6-7% and 16%, respectively, boosting total export growth by 1.4%.

Overseas active funds have turned into outflows, while southbound funds are accelerating inflows. Specifically, according to data from EPFR, as of October 23, overseas active funds flowing out of the overseas Chinese capital market have expanded to 0.24 billion US dollars (compared to an inflow of 1.06 billion US dollars last week).

Meanwhile, the scale of overseas passive fund inflows has narrowed to 0.58 billion US dollars (compared to an inflow of 1.25 billion US dollars the previous week). Overseas active funds are more focused on reducing underperformance to prevent significant losses, while systematic overweights or even excessive overweights require more conditions and stronger expectations. Southbound funds accelerated inflows this week to 36.47 billion HKD, with a daily average of 7.29 billion HKD, expanding from the previous week's daily average of 4.89 billion HKD.

Author of this article: Liu Gang (S0080512030003), Wu Wei, Zhang Weihan, Wang Muyao. Source: Kevin Strategy Research. Original title: "CICC | Hong Kong Stocks: Trading Strategy Before the Election".

Editor/ping