Source: China International Capital Corporation
Authors: Liu Gang, Wang Muyao, etc.

Main text

What is the outlook after the pullback?

Market trend review

Affected by the 'Trump Trade' leading to the increase in US bond rates and the dollar, as well as Trump's nomination of hawks towards China, the Hong Kong stock market experienced a significant pullback this week. In terms of indices, Hang Seng Enterprises, Hang Seng Index, and MSCI China fell by 6.5%, 6.3%, and 5.9% respectively, while Hang Seng Technology dropped by 7.3%. Across sectors, all sectors experienced declines, with real estate (-10.6%), insurance (-8.4%), commodities (-8.4%), and diversified finance (-8.3%) leading the losses, while defensive sectors like telecommunications (-0.1%) saw the smallest decline.

Chart: Last week, the MSCI China Index fell by 5.9%, with real estate, insurance, and commodities leading the decline.

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").

Last week, the Hong Kong stock market experienced a significant pullback with the Hang Seng Index falling by over 5%, mainly due to the drag of risk premiums (-5.5%), while the impact of risk-free rates (-0.8%) and earnings (-0.4%) was limited. The Hang Seng Index fell back below 19,500 points, basically erasing the gains since September 24 and approaching the key support levels of the daily and monthly lines. Meanwhile, overseas active and passive funds continued and accelerated their outflow last week, with the outflow scale of active funds over the past five weeks being 2-4 times the previous inflow, and passive funds also seeing outflows of 12-13% of the previous inflows.

Chart: EPFR statistics on foreign inflows into the Chinese market, categorized by investment direction

We previously indicated that the hang seng index at 22,500 points was overly accounted for in expectations and difficult to maintain, and believed that fluctuations around 20,000 points would not pose significant issues. After a month of sideways movement near 20,000 points, it suddenly broke downward last week, mainly due to external factors: first, the inertia of the "Trump trade" continued to push up the dollar and 10-year t-note rates; second, nominations of some hawkish members towards china made previously "ignored" risks suddenly tangible, leading to a more pronounced reaction in Hong Kong stocks and offshore renminbi compared to onshore assets. We have pointed out that some assets, such as the china market and export chains, do not react significantly to the "Trump trade," mainly because the market focuses more on domestic policy hedging, indicating a disparity in expectations, thus requiring attention to disturbance risks.

So, what are the prospects at this point and will it fall below previous lows? The market has different views on this. Short-term disturbances depend on the extent and frequency of external impacts; but the medium-term outlook still depends on the intensity of domestic policy hedging and the situation of fundamentals. We believe that short-term external disturbances are increasing, so stay cautious. Further volatility cannot be ruled out, but the oscillation pattern remains the benchmark assumption, and there is no need to be overly pessimistic.

► First, from a technical perspective, after the recent pullback, the short sell turnover ratio of Hong Kong stocks has increased to 17.1%, the 5-day moving average is 15.5%, the highest since the end of September; at the same time, the 14-day RSI relative strength index has dropped to 39.6, close to oversold levels. Around the 19,000-point mark is where the daily, weekly, and monthly lines intersect, forming a critical support level. We calculate that if risk rates and earnings remain at current levels, the risk premium will rise to the average level of 8.4% since 2024, corresponding to the Hang Seng Index at 18,000 points. However, a rapid increase in the risk premium to this level also implies larger shock expectations and assumes that policy hedging is not timely. In 2018, during the escalation of trade tensions, the risk premium reached as high as 7.8%.

Chart: Recently, the Hang Seng Index risk premium has risen to around 7.5%, with the highest risk premium reaching 7.8% during the escalation of trade tensions in 2018.

Chart: We calculate that if risk rates and earnings remain at current levels, the risk premium will rise to 8.4%, corresponding to the Hang Seng Index at 18,000 points, but implying even greater shock expectations.

> Secondly, external disturbances are the short-term focus. On November 14, Federal Reserve Chairman Powell stated that the current economic situation in the United States suggests that the Fed does not need to "rush" to cut interest rates, followed by a downgrade in market expectations for a December rate cut in the CME interest rate futures market (currently a 62% probability of a rate cut). Since September, the yield on the 10-year Treasury note has continued to rise to 4.44%, hitting a new high since July, and the U.S. dollar has remained strong, both suppressing the performance of the Hang Seng Index.

> More importantly, the nominations of hawkish members within Trump's cabinet have also dampened investor sentiment. Regarding the cabinet appointments, Trump nominated Rubio as Secretary of State with a tough stance on China, Waltz as National Security Advisor, and there are speculations that Trump may nominate Lighthizer to continue as the Trade Representative, advocating Strategic decoupling, all of which have increased market concerns about policy risks after Trump officially takes office in January next year, especially regarding tariffs. A potential 60% comprehensive tariff could have a significant impact on China's exports and domestic demand. Before officially taking office, based on the experience in 2016, the "Trump trade" may still have some inertia, suppressing the market through U.S. bond rates and the dollar. At the same time, theoretically, tariff policies can be activated immediately through executive orders after taking office, which is a key point to watch.

> Chart: The 10-year U.S. Treasury bond yield has risen to 4.4%.

> How can domestic policies hedge against this? Referring to the experience of the 2018 trade friction, there are several channels mainly:

1) Exchange rates: Looking at it statically, our calculations suggest that if the yuan depreciates against the dollar by 7-10%, it could offset most of the negative impact from tariffs. During the China-US trade friction in 2018-2019, the yuan depreciated against the dollar by over 11%. However, considering Trump's plan to weaken the dollar to reduce the trade deficit and attract manufacturing back, while domestically hoping to maintain a basic stability in the exchange rate, the fluctuation space for the yuan may be limited.

> Chart: Exchange rates are a significant hedging channel for tariffs. During the 2018-2019 China-US trade friction, the RMB depreciated by over 11% at one point.

2) Stimulating domestic demand: With weak exports and insufficient exchange rate depreciation room, the necessity for fiscal stimulus to bolster domestic demand increases. Our calculations indicate that an additional fiscal expenditure of 2-3 trillion yuan could counteract the aforementioned impacts. Furthermore, on November 15, the Ministry of Finance and the State Administration of Taxation announced adjustments to the export tax rebate policy to reduce exports of related categories in response to the USA's upcoming tariff increases on China.

Chart: Broad fiscal deficit impulse measurement. Historically, when exports are weak, policies are strong.

► Furthermore, although external disruptions are difficult to completely avoid, domestic fundamentals and policy efforts remain crucial. After the policy shift at the end of September, growth-stabilizing policy efforts promoted the marginal recovery of economic and financial data in October, reflected in:

1) Consumer improvements supported by subsidy policies, the National Day holiday, and the "Singles' Day" sales event. In October, total social retail sales increased by 4.8% year-on-year (vs. 3.2% in September), exceeding market expectations. The scrappage policy continues to be effective, with retail sales of autos and household appliances increasing year-on-year to 3.7% and 39.2%, respectively.

Chart: Marginal improvement in October social retail sales, with auto retail year-on-year growth reaching 3.7%.

2）Investment in production remains flat year-on-year. In October, industrial value added increased by 5.3% year-on-year (compared to 5.4% in September); Fixed asset investment in October grew by 3.4% year-on-year, staying steady with September. Infrastructure and manufacturing investment have improved slightly, remaining the main support.

3）Real Estate: Sales are recovering but volume is better than price, and investment remains weak. In October, the year-on-year decline in commercial housing sales area narrowed significantly from -11.0% in September to -1.6%, while the year-on-year decline in second-hand house prices increased slightly from -9.0% in September to -8.9%. Real estate investment indicators remain weak, with new residential construction and construction declines in October of -26.7% and -12.4% respectively, widening further from September's -19.9% and -12.2%.

Chart: Real estate sales rebounded in October but investment remains weak.

4）In financial data, the monetary growth rate has rebounded, with year-on-year growth in household credit, M1 year-on-year growth increased from -7.4% in September to -6.1% in October, M2 year-on-year growth increased from +6.8% in September to 7.5% in October. The main support comes from fiscal deposit release and household allocation of risk assets. 1.4 trillion yuan of new social financing in October, an increase of 448.3 billion yuan year-on-year, below market expectations. Government bonds are weakened by the high base effect, corporate financing demand is weak, but the household sector has added 160 billion yuan in new credit, a year-on-year increase of 194.6 billion yuan, with medium and long-term loans turning positive year-on-year. The combination of policies in real estate, and monetary policies is showing initial effects.

Chart: Year-on-year growth rates of M1 and M2 increased in October.

► Undoubtedly, policies have provided support for fundamental recovery, but are they sufficient and sustainable? High-frequency data shows signs of weakening in production, consumption, and real estate recently. 1）Production: Production weakened compared to the same period last year, with a 14.8% year-on-year decline in the operating rate of petroleum asphalt units and an 8.2% year-on-year decrease in rebar production; 2）Consumption: Passenger vehicle retail and wholesale sales maintained double-digit growth last week, but the growth rate narrowed significantly compared to the previous week; 3）Real Estate: As of November 8, the transaction area of commercial housing in 30 cities decreased by 28.3% from the previous week, with the index of second-hand house listing prices continuing to decline. CICC Real Estate Group pointed out that sales data since November may indicate a peak. Therefore, more incremental policy support is still needed for sustained fundamental recovery.

So, what scale is sufficient? It has been mentioned that the root of all current issues, including weak demand, sluggish inflation, and weak crediting leading to unimpressive profits, lies in credit contraction, caused by the ongoing inversion between return expectations and financing costs. To address this issue, first, the financing costs need to be further reduced. Our static estimation suggests that a further reduction of 40-60bp in the 5-year LPR could eliminate the inversion. However, constraints from domestic and international interest rate differentials and exchange rates, along with the duality in financial resource allocation, might limit the space and effectiveness. Secondly, return expectations must be boosted. On one hand, this can be achieved by reawakening the private sector's willingness to leverage in the stock and real estate markets, although the difficulty lies in managing the pace and recovering from expectations that have been overdrawn. On the other hand, a more effective method involves direct fiscal intervention, indirectly subsidizing enterprises and residents by paying off debts and salaries or directly implementing demand-side stimuli such as trade-in programs and fertility subsidies. Nevertheless, a considerable scale is necessary; our calculations suggest that an additional bond issuance scale of 7-8 trillion yuan is required. However, the 'real constraints' of high leverage, interest rates, and exchange rates imply that incremental stimulation will occur, but overly high expectations are unrealistic.

Chart: Our calculations show that if the overall social finance growth rate is restored to 10%, it would require an additional issuance scale of 7-8 trillion yuan.

On the allocation front, we believe that the market still mainly consists of fluctuations and structural trends. We recommend closely monitoring the December Central Economic Work Conference, Trump's cabinet formation, and policy progress related to tariffs on China. Larger fluctuations may bring more stimulus support, while fewer shocks correspond to maintaining the status quo. Under the assumption of an overall volatile pattern, the shift towards structurally 'gradually positioning on the left side in a downturn, and moderately profiting on the right side in an upturn' seems to be an effective strategy. In terms of industries, we recommend focusing on three categories: firstly, sectors related to industry self-supply and policy cycle clearing, which would perform better if there are marginal improvements in demand, such as certain consumer and service sectors, electronics, household appliances, textile apparel, and the internet. Secondly, sectors benefiting from policy support, such as household appliances and automobiles under trade-in programs, as well as trends in independent technology areas like computers and semiconductors. Thirdly, areas with stable returns, such as state-owned enterprises with high dividends.

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) China's economic data for October shows marginal improvement. In October, total social retail sales grew by 4.8% year-on-year, an increase of 1.6 percentage points from the previous month. From January to October, fixed asset investment grew by 3.4% year-on-year, maintaining the same pace as from January to September. Within this period, general infrastructure investment grew by 9.3% year-on-year, consistent with the growth rate from January to September; manufacturing investment in the same period increased by 9.3% year-on-year, slightly below the 9.2% from January to September. Regarding real estate, from the sales perspective, the year-on-year decline in national commodity housing sales area and value saw a significant narrowing from 11.0% and 17.1% in September to -1.6% and -1.0% in October respectively. In terms of prices, the year-on-year growth rate of the prices of new houses in 70 cities decreased slightly from -6.1% in September to -6.2%, while prices of second-hand homes improved slightly from -9.0% in September to -8.9% year-on-year.

2) China's financial data for October indicates a rebound in money supply growth and a year-on-year increase in household crediting. In October, the M2 balance grew by 7.5% year-on-year, a 0.7 percentage point increase from the previous month; M1 decreased by 6.1% year-on-year, narrowing by 1.3 percentage points from the previous month. This marks the first speed rebound in 2024. In October, there was a new social financing of 1.4 trillion yuan, less than the previous year's increase by 448.3 billion yuan, leading year-on-year growth rate to fall slightly from 8% in September to 7.8% in October. New RMB loans in October increased by 500 billion yuan, with 238.4 billion yuan less increase year-on-year. Government bond and bill financing saw a combined decrease of 662.4 billion yuan year-on-year, while household loans had a year-on-year increase of 194.6 billion yuan. Furthermore, the weighted average interest rate for new corporate loans in October was around 3.5%, and for new individual housing loans was around 3.15%, both at historical lows.

3) The US CPI market for October met expectations, with the core index continuing to decline on a monthly basis but rising year-on-year compared to September. In October, the CPI in the US increased by 2.6% year-on-year, marking the first time since March for a month-to-month acceleration, as forecasted by the market, previously rising by 2.4%; the month-on-month growth rate remained at 0.2%. The core CPI in October increased by 3.3% year-on-year, with a month-on-month increase of 0.3%, both matching previous values as expected. The main factors influencing the inflation data for October were the surge in oil prices and port strikes, leading to CPI rebounding due to a shrinkage in energy commodity decline and an increase in energy services; while the rebound in core CPI mainly came from services, especially equivalent rent and hotels.

4) 财政部等三部门发布多项楼市税收优惠新政。契税方面，将现行1%低税率优惠的面积标准由90平方米提高到140平方米，并明确北京、上海、广州、深圳4个城市可以与其他地区统一适用家庭第二套住房契税优惠政策。调整后，在全国范围内，个人购买家庭唯一住房和家庭第二套住房，只要面积不超过140平方米的，统一按1%的税率缴纳契税。土地增值税方面，将各地区预征率下限统一降低0.5ppt，各地可以结合实际情况进行调整[7]。

5) 海外主被动资金流出扩大，南向资金加速流入。具体看，来自EPFR的数据显示，截至11月13日，海外主动型基金流出海外中资股市场扩大至0.34 billion美元（vs. 此前一周流出0.22 billion美元），海外被动型基金流出0.81 billion美元（此前一周流出0.01 billion美元）。与此同时，南向资金上周流入加速至35.68 billion港币，较此前一周流入32.33 billion港币扩张。

图表：海外主被动外资均加速流出

Key events to watch

11月27日美国核心PCE、11月30日中国PMI、12月中央经济工作会议。

[1]https://www.bloomberg.com/news/articles/2024-11-14/fed-s-powell-says-no-need-to-hurry-rate-cuts-with-economy-strong

[2]https://www.reuters.com/world/us/trump-says-he-is-nominating-senator-rubio-secretary-state-2024-11-13/

https://docs.house.gov/meetings/ZS/ZS00/20230517/115974/HHRG-118-ZS00-Wstate-LighthizerR-20230517.pdf

http://www.pbc.gov.cn/goutongjiaoliu/113456/113469/5501759/index.html

https://szs.mof.gov.cn/zhengcefabu/202411/t20241115_3947628.htm

https://www.research.cicc.com/zh_CN/report?id=354889&entrance_source=ReportList

https://www.gov.cn/zhengce/zhengceku/202411/content_6986750.htm

Editor / jayden