After the rate cut is implemented, how much room for rebound does the Hong Kong stock have?

Abstract Boosted by the Federal Reserve's "unconventional" 50bp rate cut, the Hong Kong stock market surged significantly last week. As we have consistently pointed out, Hong Kong stocks demonstrate greater resilience in the short term compared to A-shares due to their sensitivity to external liquidity and the linked exchange rate system with Hong Kong following rate cuts. So, how significant is the impact of the rate cut, and how much further room for rebound is there? 1) Why does Hong Kong stocks have greater resilience? The main focus of observing the impact of the Federal Reserve's rate cut lies in how the effects of loose external conditions are transmitted. Hong Kong stocks, due to their linked exchange rate system with the US dollar, experience a more direct transmission of US monetary policy. 2) Which sectors of Hong Kong stocks are expected to outperform in the short term? Firstly, growth sectors that are more sensitive to interest rates are expected to benefit directly. Secondly, Hong Kong local dividends, consumption, and even real estate are expected to benefit from the Hong Kong Monetary Authority and local banks directly reducing financing costs; finally, some sectors in the export chain are also expected to benefit from potential increases in US interest rate-sensitive sectors such as real estate demand. 3) How is the funding situation? Historical experience shows that among the three factors determining foreign capital flow (overseas liquidity, geopolitics, and domestic fundamentals), domestic fundamentals and policy efforts are often more crucial. 4) How much room is there left for this round of rebound? The Federal Reserve's rate cut can bring about short-term greater resilience, but long-term sustained growth still relies on domestic economic growth and policies. Assuming US bond rates of 3.7-3.8%, a risk premium returning to the historical average of 7%, this corresponds to the Hang Seng Index reaching 19,500-20,500 points. Greater room for growth would require further policy efforts to drive fundamental restoration. In the short term, Hong Kong stocks continue to demonstrate greater resilience compared to A-shares due to their sensitivity to external liquidity and following rate cuts. On an industry level, attention can be directed towards interest rate-sensitive growth stocks (internet, technology growth, biotechnology, etc.), Hong Kong stocks with local dividends and real estate, and export chains driven by US real estate demand. However, in the medium term, it is not advisable to extrapolate short-term resilience too linearly, and a structural market movement of wide-range volatility (high dividends + technology growth) remains the main theme until more significant fiscal support is seen. Main body How much room is there for a rebound post rate cut? Market Review Boosted by the Federal Reserve's "unconventional" 50bp rate cut, the Hong Kong stock market surged significantly last week, with the Hang Seng Index rising by 5.1% to above 18,000 points, and the Hang Seng Tech Index soaring by 6.4%. The Hang Seng state-owned enterprises and MSCI China indexes also rose by 5.1% and 4.4% respectively. At the same time, the Hong Kong stock market saw a rare situation of overall sector growth, with sectors directly benefiting from the Federal Reserve and local rate cuts, as well as real estate (+7.8%), materials (+6.6%), consumer discretionary (+6.3%) leading the gains, while diversified financials (+1.5%) and information technology (+1.7%) showed lower increases. Chart: Last week, the MSCI China index rebounded significantly, with real estate and materials leading the gains, but diversified financials and information technology showed relatively limited increases. Data source: FactSet, CICC Research Department Market Outlook Last week, the most anticipated event for global investors was the official start of the Federal Reserve's rate cut, marking the first rate cut since the significant easing in response to the COVID-19 pandemic in March 2020, and also signaling the end of the rapid tightening cycle to combat inflation since March 2022. Although a rate cut was already a market consensus, the decision between a 25bp and 50bp cut remained uncertain until the last moment, with pros and cons for each option. The final outcome exceeded Wall Street's general expectations, with an unusual 50bp "unconventional" rate cut to kick off. The benefit of an "unconventional" rate cut is the ability to quickly respond to "potential but not yet evident" growth pressures, but the downside is the risk of raising concerns about "solidifying" recession worries. After all, historically, such "unconventional" rate cuts are usually drastic measures, such as during the 2001 dot-com bubble, the 2007 financial crisis, and the 2020 pandemic. It is for this reason that Federal Reserve Chairman Powell emphasized the absence of recession signs, avoided linearly extrapolating the rate-cut path, pointed out that the natural rate of interest is higher than historical levels, and presented a more gradual path in the dot plot compared to market expectations, in a multi-pronged approach to create an image of being "ahead of the market," able to do more at any time, but not forced to act more hastily due to recession pressures. In the short term, the global market's response has been positive, with a preference for loose trading conditions, leading to the S&P 500 index hitting historic highs, with growth stocks showing larger gains. In this context, as we have highlighted in several reports including "Chinese Market under the Federal Reserve Rate Cut," Hong Kong stocks, due to their sensitivity to external liquidity and the linked exchange rate system with Hong Kong following rate cuts, have demonstrated greater resilience in the short term, with Hong Kong stocks witnessing a significant rebound this week to "regain lost ground," while A-shares continue to show lackluster performance. So, how significant is the impact of the rate cut, and how much further room for rebound is there? 1) Why does Hong Kong stocks demonstrate greater resilience after the Federal Reserve's rate cut? For the Chinese market, including Hong Kong stocks, the central focus when observing the impact of the Federal Reserve's rate cut lies in how the effects of loose external conditions are transmitted and how domestic policies respond in this environment after the Federal Reserve offers loose conditions. Compared to A-shares, Hong Kong stocks, due to their linked exchange rate system with the US dollar, experience a more direct transmission of US monetary policy. Following the Federal Reserve's rate cut, the Hong Kong Monetary Authority promptly reduced the benchmark interest rate from 5.75% to 5.25%, and Hong Kong commercial banks also lowered their prime lending rate by 25bp, reducing local financing costs in Hong Kong, directly improving the liquidity environment for the Hong Kong dollar, and providing a more direct transmission of the Federal Reserve's loose conditions. In contrast, constrained by various factors such as interest rate differentials and exchange rates, the unexpected decision on Friday to keep the September LPR unchanged meant that the loose overseas environment could not be effectively transmitted, explaining the significant differences in the market performance of A-shares and Hong Kong stocks in these two days. Additionally, the differences in Hong Kong stock industry structure leading to better profitability, more thorough valuation, and position clearance also contribute to the greater resilience of Hong Kong stocks. 2) Which sectors of Hong Kong stocks are expected to outperform in the short term? Firstly, growth sectors that are more sensitive to interest rates are expected to benefit directly. Secondly, Hong Kong local dividends, consumption, and even real estate are expected to benefit from the Hong Kong Monetary Authority and local banks directly reducing financing costs; finally, some sectors in the export chain are also expected to benefit from potential increases in US interest rate-sensitive sectors such as real estate demand. 3) How is the funding situation? Historical experience shows that among the three factors determining foreign capital flow (overseas liquidity, geopolitics, and domestic fundamentals), domestic fundamentals and policy efforts are often more crucial. 4) How much room is there left for this round of rebound? The Federal Reserve's rate cut can bring about short-term greater resilience, but long-term sustained growth still relies on domestic economic growth and policies. Assuming US bond rates of 3.7-3.8%, a risk premium returning to the historical average of 7%, this corresponds to the Hang Seng Index reaching 19,500-20,500 points. Greater room for growth would require further policy efforts to drive fundamental restoration. In the short term, Hong Kong stocks continue to demonstrate greater resilience compared to A-shares due to their sensitivity to external liquidity and following rate cuts. On an industry level, attention can be directed towards interest rate-sensitive growth stocks (internet, technology growth, biotechnology, etc.), Hong Kong stocks with local dividends and real estate, and export chains driven by US real estate demand. However, in the medium term, it is not advisable to extrapolate short-term resilience too linearly, and a structural market movement of wide-range volatility (high dividends + technology growth) remains the main theme until more significant fiscal support is seen.Sexual reasons ("Hong Kong stocks have greater resilience").chart: Recent trends in the Hong Kong stock market and A shares show a clear differentiation, with a more pronounced performance after the Fed's rate cut Data source: Wind, CICC Research Department Chart: Following the Fed's rate cut, the Hong Kong Monetary Authority and local commercial banks also lowered the prime loan rate by 25bp last week Data source: Bloomberg, CICC Research Department 2) Which sectors of the Hong Kong stock market are expected to outperform in the short term? Based on the same logic, the degree of industry-level benefits also depends on the sensitivity to loose transmission. Firstly, after the Fed cuts rates, growth sectors that are more sensitive to interest rates, such as Hang Seng Technology, biotechnology, and technology growth, are expected to directly benefit in market performance. This is also the logic behind the biotechnology sector leading the market since the rapid decline in US bond rates in July. Secondly, with the Linked Exchange Rate System, the Hong Kong Monetary Authority and local banks lowering interest rates will directly reduce Hong Kong's local financing costs. Local dividends, consumption, and even real estate in Hong Kong are expected to benefit, with the MSCI Hong Kong Index almost leading major global indices last week, with sectors like discretionary consumption and finance leading the rally. Lastly, as we assess that this round of US rate cuts will not lead to a deep recession, the rapid decline in interest rates can boost industries sensitive to US rates, such as increasing demand in the real estate sector, which in turn has a positive impact on the export chain. Recently, sectors related to the export real estate chain, such as the appliance sector, have also performed well. Chart: Last week, the MSCI Hong Kong local index almost led major global indices, with discretionary consumption, industrial, and financial sectors leading the rally Data source: Bloomberg, CICC Research Department 3) How is the funding situation, and are foreign funds flowing in? From the transmission mechanism perspective, during the Fed rate cut cycle, the narrowing of interest rate differentials between the US and other countries and the temporary weakness of the US dollar help alleviate outflow pressures on emerging markets. Additionally, although rate cuts do not necessarily indicate a "recession," they often accompany a phase of growth slowdown in the US, which may drive funds to seek higher returns elsewhere. In last week's rebound in the Hong Kong stock market, we noticed an accelerated inflow of funds from the southbound channel (Funds flow after the rate cut opening). Due to the EPFR's statistics only capturing information until Wednesday, it cannot reflect the changes in funds on Thursday and Friday post the rate cut. Foreign capital continued to flow into A shares and Hong Kong stocks last week, though the inflow size decreased. However, we believe that some speculative funds are likely to re-enter the market. Next week's data will provide a clearer picture. As for more long-term fund inflows, it's not solely determined by rate cuts, historical experiences show that among the three factors that determine foreign capital flows (foreign liquidity, geopolitical factors, and domestic fundamentals), domestic fundamentals and policy actions are more crucial. During the 2019 Fed rate cuts, foreign capital continued to flow out due to relative weak domestic fundamentals and the impact of the China-US trade friction, resulting in wide market fluctuations. Contrastingly, in 2017, despite the Fed's rate hikes, foreign capital flowed into the Chinese market, showcasing this point vividly through index-level increases. Chart: During the 2019 Fed rate cut period, foreign capital continued flowing out of China due to weak domestic fundamentals and other factors Data source: EPFR, Bloomberg, CICC Research Department 4) How much upside potential does this rebound have? Historical experiences from the six Fed rate cut cycles since the 1990s show that in the short term, the Hang Seng Index has greater elasticity. After a rate cut, the Hang Seng Index on average increased by 3.8% in one month. However, relying solely on this simple historical data that doesn't consider the macroeconomic background can only serve as a rough reference; it's more important to focus on historical stages that are similar to the current situation. We believe the current scenario is more similar to the 2019 cycle, where neither a US recession nor strong domestic stimulus is certain. During the 2019 cycle, A shares and Hong Kong stocks saw a significant rebound between January and March when Powell announced a halt to rate hikes, not during the official rate cuts period from July to September. The reason for this was that when Powell announced the halt to rate hikes in early 2019, China also decided to reduce reserve requirements, creating a resonance between domestic and foreign stimulus. Conversely, after April, policies shifted towards "monetary policy overall", contrary to the Fed's loosening, hence even with the Fed's official rate cut in July, A shares and Hong Kong stocks remained in a period of fluctuations overall. Referring to the 2019 experience, after the rate cuts, growth stocks strengthened, with sectors like healthcare, discretionary consumption, and information technology leading the rally; the RMB exchange rate did not significantly strengthen; foreign capital continued to flow out until September 2020 (How does the rate cut affect Hong Kong stocks?). In other words, the Fed's rate cuts can provide temporary higher elasticity, but long-term and sustained increases still rely on domestic growth and policy actions. Chart: For example in 2019, a strong market rebound occurred from January to March when domestic policies were eased, but after April despite the Fed rate cuts, the market still showed structural trends Data source: Bloomberg, CICC Research Department In the recent 4.4% rebound of the MSCI China Index, risk premiums played a dominant role, contributing over 4ppt, while risk-free rates made a slight contribution of around 0.3ppt. We calculated that 1) considering that the current 10-year US bond rate has already factored in rate cut expectations at 3.6-3.7%, assuming the US bond rate remains at 3.7-3.8% and risk premiums return to the 7% average of the past 5 years (currently at 8.7%, reaching a low point of about 6.7% in May this year, and 6.1% at the start of 2023), the Hang Seng Index could reach around 19,500-20,500 points; 2) a larger potential requires further policy efforts to drive fundamental repairs. Currently, we forecast a 2% annual growth from the ground up (the market's consensus of about 10% might be overly optimistic). However, this expectation has not been realized in the short term, as last week's disappointment in the September LPR rate cut reflects the high threshold for expectations of "strong stimulus." Subsequent rate cuts in existing housing loans, the possibility of further rate cuts, and greater fiscal support are all directions to be watched. Chart: During the past week's market rebound in Hong Kong, risk-free rates contributed approximately 0.3ppt, while risk premiums falling contributed over 4ppt Data source: Bloomberg, CICC Research Department Chart: If the 10-year US bond rate remains at 3.7-3.8% and risk premiums return to the average since 2018, the Hang Seng Index could rebound to the 19,500-20,500 level Data source: Bloomberg, CICC Research DepartmentProfit growthData source: Bloomberg, CICC Research Department In terms of operations, in the short term, Hong Kong stocks are still more elastic than A-shares because they are sensitive to external liquidity and have followed Hong Kong in reducing interest rates. At the industry level, attention can continue to be paid to interest-rate-sensitive growth stocks (such as internet, technology growth, biotechnology, etc.), local dividends and real estate in Hong Kong, and export chains driven by US real estate demand. However, in the medium term, we also suggest not to extrapolate the short-term elasticity too linearly. Similar to the logic of the rebound in April-May, structural fluctuations in a wide range (high dividends + technology growth) still remain the main line until larger fiscal support is seen. First, high dividends, as stable "cash" return assets to cope with the long-term overall decline in returns, still have long-term value for allocation and can take advantage of the recent pullback opportunity to enter at the right time, although internal dividends follow the economic environment in the order of cycle dividends, bank dividends, defensive dividends, government bonds, and cash. Secondly, some sectors supported by policy or upward economic trends are still expected to benefit from positive boosts, such as those with their own industry prosperity (internet, gaming, education) or policy-supportive technology growth (technology hardware and semiconductor). Charts: Taking 2019 as an example, domestic policies eased significantly in the first quarter, resulting in a substantial rebound in the market. However, from April onwards, even with the Fed cutting interest rates, the market continued to show structural fluctuations. Data source: Wind, CICC Research Department Charts: Performance of the Shanghai Composite Index after interest rate cuts in the past Data source: Wind, CICC Research Department Charts: Performance of the Hang Seng Index in Hong Kong after interest rate cuts in the past Data source: Wind, CICC Research Department Charts: At the beginning of interest rate cuts, Hong Kong stocks rebound significantly outperforming A-shares, with a higher probability of increase. Data source: Wind, CICC Research Department Specifically, the main logic supporting our above views and the key changes to watch this week include: 1) The "shoe drop" of the Federal Reserve's interest rate cuts, starting with an unconventional 50bp cut, exceeded market expectations. On September 19 Beijing time, as scheduled, the Federal Reserve started cutting interest rates, but the magnitude of the cut surprised the market with a "non-traditional" 50bp cut, lowering the federal benchmark rate to 4.75%-5%. In history, instances of starting with a 50bp rate cut only occurred in times of economic or market emergencies, such as the tech bubble in January 2001, the financial crisis in September 2007, and the pandemic in March 2020. At the same time, the updated "dot plot" predicts two more interest rate cuts totaling 50bp this year, four cuts totaling 100bp in 2025, and two cuts of 50bp in 2026, in addition to this 50bp cut, bringing the total cut to 250bp with an interest rate endpoint of 2.75-3%. At the same time, in order to dispel the market's linear extrapolation of the current rate cut path, Powell also emphasized that there is no fixed rate path, it can be accelerated, slowed down, or even paused, depending on each meeting. And emphasized that there are no signs of a recession, the labor market is cooling down, but has not yet conquered the inflation issue. 2) The recovery of domestic tourism consumption during the Mid-Autumn Festival holiday is relatively good. The per capita tourism consumption of domestic tourists during the 2024 Mid-Autumn Festival holiday has reached a new high compared to the recovery level in 2019. According to the data center of the Ministry of Culture and Tourism, there were 107 million domestic trips during the holiday, an increase of 6.3% compared to the same period in 2019; domestic tourists spent a total of 51.047 billion RMB on trips, an increase of 8.0% compared to the same period in 2019; per capita tourism consumption has recovered to 101.6% of the same period in 2019, surpassing the recovery levels of this year's New Year's Day, Spring Festival, Qingming Festival, May Day, and Dragon Boat Festival, reaching a new high of recovery level. Especially under the background of a strong typhoon hitting the East China region this year, it was still able to achieve a good recovery. The upcoming Golden Week during the National Day holiday is also worth paying attention to in terms of recovery. 3) LPR remains unchanged temporarily in September. The LPR quotations announced by the central bank on September 20 showed that the 1-year and 5-year LPR quotations remained unchanged at 3.35% and 3.85%, respectively. The temporary stagnation of LPR this time may be due to considerations of the continuous decline in banks' net interest margins in recent years and constraints such as the yuan exchange rate. Recently, Zou Lan, the director of the monetary policy department of the central bank, also clearly pointed out that short-term interest rate cuts may still face constraints due to factors such as "deposit migration" and the extent of the narrowing of bank net interest margins. Therefore, the central bank needs to consider the impact of subsequent reductions in mortgage rates and interest rates on banks' net interest margins. 4) Southbound capital continued to flow in this week, while overseas active capital continued to flow out. Specifically, data from EPFR shows that as of September 18, overseas active funds continued to flow out of the overseas Chinese market, with outflows of approximately $150 million, narrowing from $250 million the previous week, marking the 71st consecutive week of outflows. At the same time, outflows of overseas passive funds increased to $180 million (compared to $100 million the previous week). However, the direction of foreign funds after the Fed's interest rate cut will need to wait for next week's data to reflect. Southbound funds continued to flow in this week, with inflows of HK$6.0 billion in just two trading days, down from HK$12.53 billion the previous week. Charts: As of last Wednesday, overseas active funds continued to flow out of the overseas Chinese market Data source: EPFR, Wind, CICC Research Department Key events to focus on September 26: US GDP and PCE data, September 27: Chinese industrial enterprise profits. This article is sourced from the WeChat public account "Kevin Strategy Research," authored by CICC analysts Liu Gang, Zhang Weihan, etc.; GMTEight editor: Wenwen.