CICC: How Will Interest Rate Cuts Impact Hong Kong Stocks?

Summary Last week, the Chinese and overseas markets showed divergent trends. The US stock market rebounded significantly due to factors such as the expectation of a rate cut by the Federal Reserve, while conversely, the A-share market weakened in the face of relatively weak domestic economic data and policy expectations. In this context, the Hong Kong stock market's independent and distinct volatile trend from A-shares is easily understood, reflecting its characteristic of "Chinese assets + foreign capital" and aligning with our consistent view that Hong Kong stocks are better than A-shares. The upcoming Federal Reserve FOMC meeting next week is undoubtedly the focus of global investors. For the Chinese market, including the Hong Kong stock market, the main impact logic to observe from the Fed rate cut is how the external easing effect will be transmitted, and how domestic policies will respond in this environment. If domestic easing measures are stronger than the Fed's, it will provide a greater boost to the market. Conversely, if the measures are limited, as is more likely under current constraints, then the impact of the Fed rate cut on the Chinese market may be marginal and localized. Recent economic data for August indicates that domestic demand remains weak and requires more policy support, including monetary easing. The Fed rate cut in September is expected to open up policy space for the central bank, but the magnitude may be limited, and expectations of a "strong stimulus" are unrealistic. Due to its sensitivity to external liquidity and the linked exchange rate arrangement with Hong Kong following the rate cut, Hong Kong stocks have greater resilience than A-shares. In terms of sectors, growth stocks sensitive to interest rates (biotechnology, technology hardware, etc.), sectors with a high proportion of overseas US dollar financing, local dividend-paying stocks, and property benefiting from the US rate cut boosting demand in the export chain may also benefit marginally. However, overall, until there is greater fiscal support seen, a wide range of volatile structural trends remains the main theme. Conclusion Market Review After experiencing a correction the previous week, the Hong Kong stock market last week overall showed volatile consolidation. Among the major indexes, the Hang Seng Tech Index fell slightly by 0.2%, the Hang Seng Index fell by 0.4%, and the MSCI China and Hang Seng China Enterprises Indexes fell by 0.4% and 0.6% respectively. In terms of sectors, benefiting from the increase in expectations for a Fed rate cut, growth sectors like healthcare (+1.7%) and consumer discretionary (+1.5%) led the way, while sectors like energy (-6.6%), real estate (-6.1%), and utilities (-5.0%) performed poorly. Market Outlook Last week, the Chinese and overseas markets showed divergent trends. The US stock market rebounded significantly due to factors such as the increase in expectations for a Fed rate cut, with the S&P 500 rising by 4% for the week, and the Nasdaq surging by 6%. Conversely, A-shares weakened in the face of relatively weak domestic economic data and policy expectations, with the Shanghai Composite Index falling by 2.2% and approaching the 2,700 point level once again. In this context, it is easier to understand the Hong Kong stock market's independent and distinct volatile trend from A-shares, reflecting its characteristic of "Chinese assets + foreign capital" and aligning with our consistent view that Hong Kong stocks are better than A-shares. This trend is particularly evident at the sector level, with sectors more related to the domestic fundamentals like energy and real estate lagging, while sectors sensitive to interest rates like healthcare and consumer discretionary leading. Additionally, the much-awaited inclusion of Alibaba (09988) in the Hong Kong stock connect trading last week, together with significant buying of 16.4 billion HKD by southbound investors, led to overall gains of 3.7%. In the long term, based on calculations comparing with comparable Tencent, the inclusion of Alibaba in the Hong Kong stock connect is expected to bring about an incremental capital inflow of approximately 150 billion HKD. The upcoming Federal Reserve FOMC meeting next week is undoubtedly the focus of global investors. Although the market has already reached a consensus that the Fed will start cutting rates in September, the variable remains the extent of the rate cut, whether it will be 25bp or 50bp. The current CME rate futures also show a 50% probability of the market expecting a rate cut of 25bp or 50bp. The higher-than-expected core CPI for August in the US, particularly the sharp increase in rent to a new high since January, has also added uncertainty to the extent of the rate cut. The simultaneous rise in assets like the Nasdaq, industrial metals, and gold suggests that besides the clear direction of rate cuts, growth expectations remain "confused." Considering that the US is not in a deep recession and easing measures in certain areas like real estate are already showing effects, we believe that a 25bp cut is still the baseline. For the Chinese market, including the Hong Kong stock market, the main impact logic to observe from the Fed rate cut is how the external easing effect will be transmitted, and how domestic policies will respond in this environment. Considering the constraints of the Sino-US interest rate differential and exchange rate, the Fed rate cut will provide more room and conditions for domestic easing, which is needed in the current relatively weak growth environment and still relatively high financing costs. Thus, if domestic easing measures are stronger than the Fed's, it will provide a greater boost to the market. Conversely, if the extent is limited, which is more likely under current constraints, then the impact of the Fed rate cut on the Chinese market may be marginal and localized. Take the 2019 rate cut cycle for example, the significant rebound in A-shares and Hong Kong stocks in the first quarter coincided with the period when Powell announced the halt to rate hikes from January to March, rather than the official rate cuts in July to September. The reason for this was that when Powell announced the halt to rate hikes in early 2019, China also decided to cut reserve requirements, creating resonance internally and externally. Conversely, after April when policies returned to the "monetary policy thaw" with the Fed's easing direction, even with the official rate cuts in July, A-shares and Hong Kong stocks continued to consolidate overall. Conclusion The recent economic data for August indicates that domestic demand continues to be weak and requires more policy support including monetary easing. Apart from the better-than-expected exports in August, growth in areas such as prices, credit demand, and consumption investment have all weakened. Retail sales in August grew by 2.1% year-on-year, down by 0.6 percentage points from July; overall, fixedAsset investment grew by 3.4% compared to the same period last year, which is a slowdown from the 3.6% growth in the first seven months. Both land acquisition, sales, and investment in real estate remained weak. Meanwhile, in August, the demand for loans from residents and enterprises fell compared to the previous month, with medium and long-term loans increasing by 40.2 billion yuan and 154.4 billion yuan respectively year-on-year. The growth rate of social financing decreased from 8.2% in July to 8.1% in August, with an increase of 98.1 billion yuan less than the previous year, mainly due to government financing contributions. Non-government financing growth rate decreased from 6.6% in July to 6.4%, with the resident sector declining faster from 3.8% in July to 3.5%. These trends reflect weak private sector demand and the ongoing deleveraging process. Furthermore, the M1 growth rate decreased from -6.6% in July to -7.3%, indicating a contraction in business activities. In this context, increasing government leverage and expenditure expansion will be an effective and important supplement. In August, government financing growth rate increased from 15.4% in July to 15.8%, reaching the highest point since December 2023. If future expenditures continue to expand (government support increased by 295.7 billion yuan year-on-year in July, reaching a new high since December last year), it is expected to provide support for the market and growth.Charts: The year-on-year growth rate of social financing slightly weakened to 8.1% in August, while M2 growth remained flat compared to July Charts: Social financing from the household sector weakened noticeably, while government sector support for social financing was evident Charts: From the perspective of the general fiscal deficit, the year-on-year increase in July reached a new high since December last year However, at a recent press conference by the State Council Information Office, the director of the monetary policy department of the People's Bank of China, Zou Lan, clearly pointed out that there is still some room for a decrease in the average statutory deposit reserve ratio of financial institutions. However, due to factors such as "deposit migration" and the narrowing of net interest rate spreads of banks, short-term interest rate cuts may still face constraints. Therefore, the Fed's interest rate cut in September is expected to open up policy space for the central bank, but the extent may be limited. Expecting "strong stimulus" is not realistic, and the Macro Strategy Department of CITIC Securities also believes that the probability of a universal reduction in the Loan Prime Rate (LPR) is low. However, considering how overseas easing is transmitted, Hong Kong stocks have greater flexibility than A-shares because Hong Kong follows interest rate cuts due to its sensitive to external liquidity and the linked exchange rate arrangement. In addition, Hong Kong stocks have relatively better profitability, and valuation and position clearing are more thorough, which also supports the relative performance of Hong Kong stocks. Similarly, at the industry level, growth stocks sensitive to interest rates (biotechnology, technology hardware, etc.), sectors with a higher proportion of overseas USD financing, local dividend-paying stocks in Hong Kong, even real estate benefiting from the demand pull from the U.S. interest rate cut, may benefit marginally. While simple comparisons with historical averages are not advisable, on average, during the initial period of interest rate cuts, Hong Kong stocks tend to rebound significantly outperforming A-shares, and the probability of an increase is also higher. Charts: During the initial period of interest rate cuts, the rebound in Hong Kong stocks is obvious, outperforming A-shares with greater probability of increase In terms of operations, as the Fed's interest rate cut approaches, we still advise that Hong Kong stocks have greater flexibility than A-shares. If the Fed's interest rate cut exceeds expectations, especially if the People's Bank of China cuts interest rates beyond expectations, it will bring even greater flexibility. At the industry level, growth sectors benefiting from the logic on the denominator side in the short term may have higher flexibility, such as semiconductors, automobiles (including new energy), media and entertainment, software, biotechnology, etc. Sectors benefiting from local dividends due to the interest rate cut in Hong Kong are also worth paying attention to. However, overall, until we see more substantial fiscal support, the structural market with wide range fluctuations remains the main theme. In summary, the current 10-year U.S. Treasury bond rate falling to 3.6% has already incorporated the expectation of interest rate cuts sufficiently. If the risk premium returns to the level of the middle of last year, the corresponding Hang Seng Index would be around 18,500-19,000; if profits increase by 10% on this basis, the Hang Seng Index would be at 21,000. We continue with our strategic recommendations for the second half of the year, focusing on three directions within the structural market: overall return reduction (stable returns from high dividends and high buybacks, i.e. "cash cows" with ample cash flow; short-term dividends may see differentiation between local dividends in Hong Kong, low volatility dividends, and cyclical dividends), partial leverage (industries with certain economic vitality or benefiting from policy support in technology growth), partial price increase (natural monopoly sectors, utilities, etc.). Specifically, the main logic supporting our above views and the main changes to pay attention to this week are as follows: 1) The year-on-year increase in domestic CPI in August was minor, but PPI significantly slowed down. In August, the year-on-year increase in CPI slightly rose from 0.5% to 0.6%, while the year-on-year decrease in PPI notably widened from -0.8% to -1.8%, both weaker than market expectations (0.7% and -1.4%, respectively). Of the 0.1 percentage point improvement in year-on-year CPI, due to the effects of high temperatures in summer and heavy local rainfall, the year-on-year prices of fresh vegetables and fruits rose from 3.3% and -4.2% in July to 21.8% and 4.1% in August, contributing an extra 0.6 percentage points to the year-on-year CPI compared to the previous month. On the other hand, prices of non-food consumer goods and services generally slowed down, with the core CPI decreasing to a new low since April 2021. In contrast, under a backdrop of global demand decline, international commodity prices coming under pressure, and delayed efforts in maintaining stable growth domestically, the year-on-year decline in PPI widened from -0.8% in July to -1.8% in August. Charts: The increase in August CPI was influenced by higher food prices, while PPI saw a significant decline 2) Social financing growth slightly declined, with a faster decline in non-government sectors. The year-on-year growth rate of social financing in August slightly decreased from 8.2% in July to 8.1%, mainly supported by government bond financing. The financing growth rate of government sectors increased from 15.4% in July to 15.8%, with government bond net financing in August reaching 1.61 trillion yuan, an increase of 437.1 billion yuan compared to the same period last year. In contrast, the growth rate of social financing in non-government sectors decreased from 6.6% in July to 6.4%, while the financing growth rate of the household sector declined even faster from 3.8% in July to 3.5%. The year-on-year decrease in M1 in August widened to 7.3% (vs. -6.6% in July), partially reflecting the need for improvement in corporate profits. 3) Exports recovered better than expected, while imports fell below market expectations. In August, exports in USD terms increased by +8.7% year-on-year (vs. +7.0% in July), outperforming expectations. The marginal improvements were significant for the EU and emerging markets, with categories such as mobile phones, automobiles, and ships showing marked improvement in mechanical and electrical products. Despite the continued contraction in global manufacturing Purchasing Managers' Index (PMI) in August, against a backdrop of overall marginal slowdown in external demand, the better-than-expected export growth in August might be supported by factors such as the concentrated release of demand that was disrupted by typhoons in July and early acceleration by enterprises in anticipation of EU tariff increases. In comparison, imports in August rose by 0.5% year-on-year (vs. +7.2% in July) and fell below market expectations, indicating signs of weak domestic demand. Charts: Exports in August recovered better than expected, while imports notably declined 4) Retail sales growth slowed down, and fixed asset investment growth moderated. In August, total social retail sales increased by 2.1% year-on-year, a decrease of 0.6 percentage points compared to July. The year-on-year decline in automobile retail sales reached 7.3%, hitting a new low for the year. Overall, the policy on "substituting old for new" consumer goods still awaits further implementation to take effect. As for fixed asset investment, the greater decrease in PPI in August contributed to a slight increase in nominal investment growth. From January to August, fixed asset investment increased by 3.4% year-on-year (vs. +3.6% from January to July). Real estate development investment remained weak, with the decline in growth rate remaining in line with that of January to July. However, infrastructure and manufacturing investment continued to support overall investment growth, albeit with declining growth rates at the margin.Chart: Slowdown in August Social Zero Growth, Slowdown in Fixed Asset Investment Growth 5) This week, Southbound funds continued to flow in, while overseas active funds continued to flow out. Specifically, data from EPFR shows that this week overseas active funds continued to flow out of overseas Chinese A-share markets, with an outflow of approximately $250 million, an increase from the previous week's $210 million, marking the 70th consecutive week of outflows. At the same time, overseas passive funds turned into outflows of $100 million (compared to inflows of $170 million the previous week). Southbound funds continued to flow in this week, with an inflow of $12.53 billion Hong Kong dollars, an increase from the previous week's $9.27 billion Hong Kong dollars. It is worth mentioning that Alibaba, which was officially included in the Hong Kong Stock Connect last week, has been widely favored by Southbound investors. Last week, Southbound funds accumulated a total inflow of $16.42 billion Hong Kong dollars into Alibaba, ranking first. Chart: Continued outflow of overseas active funds from overseas Chinese A-share markets Key Events to Watch September 18th: FOMC Meeting by the Federal Reserve September 20th: Chinese LPR This article is reprinted from the "CICC Strategy" WeChat public account, analysts: Liu Gang, Zhang Weihan, etc.; edited by GMTEight: Huang Xiaodong.