Source: Caixin News
Author: Hu Jiarong

Since the Spring Festival holiday, the AI boom has boosted the performance of the Hong Kong stock market. As of last Friday's close,$Hang Seng Index (800000.HK)$the Hang Seng Index and the Hang Seng Technology Index have risen 20.79% and 35.12%, respectively.

In this regard, China International Capital Corporation pointed out that this wave of rising in the Hong Kong stock market mainly relies on valuation-driven factors, among which the optimistic narrative for the future accounts for the majority (reflected as the risk premium ERP). Now, having reached this point, to what extent has the valuation in the Hong Kong market been repaired, and how much room is there for future expansion?

To what position has the valuation of the Hong Kong market been repaired? From a static perspective, it still remains in the lower range of historical levels.

In a vertical comparison, the Hang Seng Index's dynamic PE has recovered from 9.1x before the Spring Festival holiday to around the historical average of 10.8x, corresponding to the 61.2% percentile since data has been available in 2013; the dynamic PE of the Hang Seng Technology has recovered from 15.6x before the Spring Festival holiday to 19.3x, still below the historical average, corresponding to the 33.2% percentile since data has been available in July 2020.

In a horizontal comparison, the dynamic PE of the Hong Kong stock market is still low compared to major global markets, and the dividend yield of the Hang Seng Index (~3.2%) is still significantly higher than the 10-year bond yield (~1.8%). Recently, the market rebound has caused the ratio of the two to decrease but it remains more than one standard deviation above the historical average.

By sector, there is a divergence between the old and new economies. The dynamic PE of the new economy has risen to 16.7x, while the old economy has risen to 6.1x, both below the average since 2015. In the segmented sectors, valuations in finance and materials have recovered to historical averages, while retail, media and entertainment, and consumer services sectors are still at historical low valuations.

At the individual stock level, under the comparable company framework, the valuations of the Hong Kong stock symbols are lower than those of major markets like the US. The average dynamic PE of China's 'Tech Ten Giants' is 21.9x, lower than the 28.4x of the US 'Tech Seven Sisters.'

China's 'Tech Ten Giants' (Hong Kong stocks) are$TENCENT (00700.HK)$、 $BABA-W (09988.HK)$ 、$MEITUAN-W (03690.HK)$、$JD-SW (09618.HK)$、$XIAOMI-W (01810.HK)$、$KUAISHOU-W (01024.HK)$、$BIDU-SW (09888.HK)$、$LENOVO GROUP (00992.HK)$、$SMIC (00981.HK)$。

The 'Seven Sisters' of the USA stock market are Apple,$Microsoft (MSFT.US)$、$Amazon (AMZN.US)$、$NVIDIA (NVDA.US)$、 $Alphabet-A (GOOGL.US)$ 、 $Meta Platforms (META.US)$ 、$Tesla (TSLA.US)$。

Therefore, from a static perspective, whether comparing with other Assets and markets horizontally or comparing historical trends vertically, the current valuation of Hong Kong stocks remains at a relatively low level within historical Range.

What has driven the rapid rebound in valuations? Looking at the dynamics, the sentiment-driven recovery is basically in place.

Valuation is the final trading result of various factors, including fundamentals, policies, liquidity, and sentiment, and can be simply broken down into financing costs and risk premiums. The former usually uses the 10-year government bond yield as the risk-free rate (considering the particularities of the Hong Kong stock market, China International Capital Corporation uses a weighted average of the China bonds and US bonds with a 30-70 split as the risk-free rate), while the latter is the aggregation or residual of other unexplained parts.

For domestic markets, such as the US stock market and China's A-shares, the risk premium consists more of local premiums made up of macro premiums (policies and fundamentals) and micro premiums (liquidity and sentiment); for offshore markets, like the Hong Kong stock market, an additional 'country premium' applicable to foreign investors needs to be added.

Since the Spring Festival holiday, the valuation of the Hang Seng Index and the Hang Seng Technology has continued to expand, while the rest has contributed to a decline in risk premium (ERP), which directly reflects the optimistic narrative and expectations. Currently, the risk premium of the Hang Seng Index has declined to 5.7%, close to the 5.4% at the market peak in early 2021, while the risk premium of Hang Seng Technology has dropped to 1.6%, below the historical average since data has been available in July 2020, narrowing the gap from the historical high of 0.3% in early 2021. The Hang Seng Technology constituents are only 30 stocks, so the index rebalancing has a significant impact with limited historical comparability of risk premiums.

The rapid decline in risk premium is due to two reasons:

The narrative shift has boosted risk appetite. DeepSeek has sparked enthusiasm in the market for reevaluating technology stocks and even overall Chinese assets, with new catalysts continually emerging, including the release of the general-purpose AI Agent product Manus, leading to a consistent improvement in investor sentiment.

Southbound funds are accelerating inflow, increasing their impact on the pricing of Hong Kong stocks. As an offshore market, the valuation of Hong Kong stocks is a shared perspective of domestic and foreign investors. According to FactSet, among the top 100 weight stocks of MSCI China, the proportion of foreign capital exceeds 65%. Foreign investors typically demand higher risk compensation based on 'national premium', which has long suppressed the valuation of Hong Kong stocks. Recently, there has been a significant inflow of southbound funds, accumulating 313.9 billion Hong Kong dollars since the beginning of the year, more than five times that of the same period last year, with southbound turnover accounting for around 30%. Reviewing the elevation in southbound turnover, it corresponds to a phase drop in AH premium, indicating that the activity level of mainland investors in the Hong Kong stock market influences the revaluation of Hong Kong stock assets.

How much expansion space is left for valuation? The dividend sector has a relative space of 5% compared to A-shares, while the technology sector has basically matched ROE.

Based on the above valuation analysis framework, the short-term changes in the risk-free interest rate are relatively limited, and more attention should be paid to changes in risk premiums. The short-term risk premium depends on the characteristics of the funds, such as the continuous increase in southbound trading, while the long-term depends on the profit outlook. If profits can be realized, there may even be a situation where the higher the increase, the lower the valuation.

传统板块：从红利思路看，长期相对国债利率还有较大空间，但相对A股空间为5%。传统板块的修复高度依赖宏观总量政策和整体经济杠杆的修复，这与“924行情”不同，因此传统板块仍以红利投资思路为主。在本轮以科技为主的反弹行情中，情绪和资金流入的加持也使得传统板块跟随上涨，虽然无法跑赢，进一步使得AH溢价从141%收敛至131%，低于历史均值以下1倍标准差，港股较A股仍存在31%的折价。

Among the 151 companies listed in both AH markets, the vast majority are state-owned enterprises and traditional sectors, with the market cap proportion of sectors such as finance, energy, telecommunications, and utilities accounting for about 80%. The higher discount on Hong Kong stocks means that dividend yields are significantly higher than those of A-shares. Even considering dividend tax (20% for individual investors on H shares, up to 28% for Red Chips; corporate investors are exempt after holding for 12 months), it still remains attractive. This partly explains why mainland southbound funds continuously favor high-dividend targets in Hong Kong stocks.$CHINA TELECOM (00728.HK)$、$CHINA SHENHUA (01088.HK)$Southbound funds' shareholding ratio has exceeded 50%.

In this sense, when the dividend yield of the same company is equal after deducting 20% tax in both A shares and Hong Kong shares, the AH premium converges to 125%, the attractiveness of dividends to southbound investors will be greatly reduced, corresponding to a space of 5% for the dividend sector relative to A shares.

Technology Sector: Current valuation is almost in line with ROE, and further space relies on profit improvement. DeepSeek has sparked the market's enthusiasm for re-evaluating Technology stocks, but after a month of continuous increases, are Technology stocks still undervalued? In absolute terms, it seems so, but considering the current profitability, further expansion requires more realization, otherwise there is also a lack of space. Domestic Technology stocks did not participate in the global ChatGPT market previously, which has widened the gap in performance and valuation between China's Technology leaders and USA's Technology leaders over the past two years. China's Technology leaders have a dynamic PE and PEG of only 17.7x and 1.41x, significantly lower than the USA's Technology leaders at 27.9x and 2.58x.

However, the high valuation of USA's Technology leaders is supported by profitability, which is a relatively weak point for current Chinese Technology stocks. Based on this ratio, the valuation is already reasonable: China's Technology leaders' circulating market cap accounts for 28.9% of all Hong Kong stocks, higher than the USA's 26.6%, but net profit contribution from China's Technology leaders is only 13.3%, lower than the USA's 15.7%.

The ROE and profit margins of USA's Technology leaders are generally higher than those of China's Technology leaders. If we assume that the overall dynamic PE (28.1x) of USA's Technology stocks is generally in line with the expected ROE (34.2%), then the overall dynamic PE (17.4x) of Chinese Technology stocks is already somewhat overvalued relative to the expected ROE (16.8%), with a reasonable valuation likely between 15-16 times.

In terms of individual stocks, under comparable companies, the dynamic P/E average of Chinese technology stocks is 21.9x, lower than the 34.5x of American technology stocks, but the average profit margin is only 13.2%, which is also lower than the 28.4% of American technology stocks.

The estimation of valuation expansion space in the Technology Sector relies more on the improvement of profitability.

If referring to the target valuation of individual stocks by analysts at China International Capital Corporation, leading Chinese technology stocks may have a 15% expansion space in valuation, though there are differences among individual stocks.

If the expected ROE of leading Chinese technology stocks can reach over 30%, then referencing the valuation of leading American technology stocks could result in a doubling of expansion. However, before earnings expectations are not significantly upgraded, the valuation expansion of technology stocks still relies on emotional boosts from event catalysts, which is also why the market has previously temporarily paused and adjusted. In a situation where static sentiment and technical aspects are overstretched, the long-term macro narrative remains to be validated but cannot be falsified in the short term, and market upward movement requires continuous catalysts.

The essence of this round of rebound is based on optimistic sentiment regarding technology trends. The extent to which this sentiment is factored in and how much 'imaginative' space remains for the future is key to answering the future market space. China International Capital Corporation believes that the current AI trend, narrative changes, and the overarching direction of valuation re-evaluation are correct, but it is also necessary to grasp the rhythm in the short term, with positions and costs being equally important. If the expectation of new short-term catalysts is limited, and there might even be risks that policies fall short of expectations or external disturbances increase, it is better to mainly adopt a wait-and-see approach in the short term.

China International Capital Corporation maintains the view that in the short term, the Hang Seng Index will be between 23,000-24,000, with an optimistic scenario calculating a point of 25,000. It is necessary to clarify that such a static calculation does not mean that reaching that point will necessarily lead to a significant decline, nor does it mean that it won’t break through with short-term funding and emotional boosts, but it indicates that before the long-term expectations can be fulfilled, the continuous overstretching of optimistic sentiment also implies the potential for increased market divergences.

Since the end of 2023, the Hong Kong stock market has experienced four rapid rebounds followed by corrections, but with an ongoing phenomenon of rising bottoms (trillions of yuan in government bonds at the end of 2023, real estate policies during the May 1 holiday in 2024, the 924 market in 2024, and post-Spring Festival market conditions in early 2025). This indicates that the force of policy is effective, hence the bottoms keep rising, and even when the market corrects, it won't completely erase prior declines; however, the market will linearly extrapolate its strength, leading to overstretched corrections after rapid surges. Therefore, the best strategy to deal with this situation is to 'actively Buy at low levels and moderately take profits during euphoria,' while focusing more on structural markets with fundamental and industrial trends.

Understand the direction of Northbound capital and stay updated with the latest investment trends!Market > Shanghai and Shenzhen Stock Connect > Hong Kong Stock Connect (Southbound)Additionally, there are several lists for you to choose from such as Top Gainers, Active Trading List, Hold Positions List, and Net Inflow List.

Editor/Rocky