China Securities Co.,Ltd.: The seven most critical issues currently facing Hong Kong's stock market.

Summary What is the main driving force behind the current rise in Hong Kong stocks? This round of market activity began at the end of January, mainly driven by DeepSeek's industry expectations. The majority of participating funds are also concentrated in the technology sector, especially in areas related to domestic AI applications. How does this round of Hong Kong stock market differ from the two rounds in May and September last year? In May of last year, the Asia-Pacific region experienced a reallocation of foreign capital, driven by fund logic; in September, the stock market was influenced by China's capital market reforms exceeding expectations, driven by macroeconomic policies; this round is driven by industry catalysts. Are foreign capital involved in the current rise of Hong Kong stocks? How do you see foreign capital in the future? Foreign capital is involved, but it shows a pulse-like pattern. In the short term, foreign capital quickly flows in for certain reasons, but once the logic reverses, hedge funds will continue to sell. Is there Southward participation in the current rise of Hong Kong stocks? How do you see Southward in the future? Southward is the core source of funding for this round of market activity, mainly focused on the dividend and internet sectors. Southward funding will continue to be an important driver of the rise in Hong Kong stocks. The difference in funding costs between domestic and foreign capital provides a basis for Southward inflows. Considering the high probability of a slowdown in the pace of interest rate cuts in the US this year, this phenomenon is expected to continue for a long time. In the short term, is the current rise in Hong Kong stocks approaching its peak? This round of rise has entered the middle stage, and the focus of future funding attention may gradually shift from technology stocks to value stocks. If Hong Kong stocks peak in the short term, which sectors will relatively resist the decline? It is recommended for investors to continue to focus on dividend and internet companies such as NETDRAGON. In the long term, has the bull market in Hong Kong stocks been established? The bull market in Hong Kong stocks is expected to continue, as liquidity, valuations, and earnings are all in an upward cycle, and waiting for policy support to exert force and economic recovery will further drive the upward trend. Text I. Introduction In the fourth quarter of last year, Hong Kong stocks faced continuous adjustments, with a pervading sense of pessimism in the market. We released a report at the end of last year when the Hang Seng Index first fell below 20,000 points, pointing out that the long-term factors in the current Hong Kong stock market had reversed, and the adjustment was an opportunity for positioning. In January, with the catalyst of the AI industry, the market ended its adjustment and ushered in a new round of upward movement. This report will focus on the most critical seven issues in the current Hong Kong stock market. II. What is the main driving force behind the current rise in Hong Kong stocks? The emergence of DeepSeek has quickly ignited the A-share and Hong Kong stock markets. Since mid to late January, driven by market sentiment, the Hang Seng Index has started a new round of rebound, surpassing 22,000 points by February 14, with a cumulative increase of nearly 20%. The Hang Seng Technology Index has risen from its low point in January to around 5,500 points, with a cumulative increase of over 30%, and has even surpassed its peak in 2024, becoming the main beneficiary of this round of market activity. The direct reason is the expectation of the Chinese AI industry brought about by DeepSeek. This round of market activity clearly started to rebound at the end of January, during the Chinese New Year period, with many uncertainties at the macroeconomic level, including Trump's trade war and the Fed's pause in interest rate cuts. Therefore, unlike past rallies dominated by policy or economic recovery, the driving factors of this round of recovery almost entirely come from industrial catalysts. From the industry ranking of Hong Kong stocks in this round and the proportion of turnover, it can be seen that the majority of participating funds are concentrated in the technology sector, especially in sectors related to domestic AI applications. DeepSeek has caused dramatic fluctuations in global markets and short-term impacts on US tech stocks. As a giant in the AI field, NVIDIA has maintained a leading advantage in the global technology industry with its leading GPU technology and sound software ecosystem. However, the success of DeepSeek has disrupted this situation and may fundamentally change the traditional competitive landscape. According to a recent report from Morgan Stanley, the expected shipment volume of NVIDIA's GB200 chip by 2025 has been lowered from 30,000 to 35,000 units to 20,000 to 25,000 units or even less than 20,000 units in the worst-case scenario. One of the main reasons is the emergence of high-efficiency open-source models like DeepSeek, which has weakened the market's potential for computational power demand. As of February 14, NVIDIA's stock price has fallen by 18.61% from its high point in January, with a market value evaporation of over $346.288 billion. Similarly, the share prices of its related companies in the industrial chain, such as Zhongji Innolight, have also experienced rapid declines. In contrast, the Hong Kong stock market has benefited from the DeepSeek factor, with the AIGC concept sector continuing to rise to 1165 points, far exceeding the peak level in 2024. The significant opportunity in the Hong Kong stock market lies in the AI+ sector, where several leading companies quickly deploy products and services based on DeepSeek, leading to significant increases in stock prices. In the AI healthcare sector, DeepSeek technology has rapidly expanded to include multiple areas such as drug development, clinical diagnosis, and health monitoring. ALI HEALTH has performed well, leading the AI healthcare sector continuously, with a rise of over 70% since the beginning of the year, and YIDU TECH and JD HEALTH also continuing to rise. In the AI automotive sector, major car manufacturers have responded by integrating DeepSeek, and He Xiaopeng, Chairman of Xpeng Motors, stated that DeepSeek will drive the software and hardware transformation of the automotive industry in the next decade. In the realm of cloud computing service providers, companies such as KINGSOFT CLOUD, Tencent Cloud, and Alibaba Cloud have successively integrated DeepSeek technology, accelerating the popularization of cloud computing and driving rapid growth in revenue from cloud service providers' computational power leasing and AI services. As a result, the stock prices of these three companies have significantly increased, with increases of 30.91%, 17.75%, and 45.63% since the beginning of the year. In the generative AI sector, MEITU has become a leader in this wave of growth, with its two major products Meitu Xiuxiu and Beauty Camera showing year-on-year performance growth and the daily user count of AIGC image processing functions exceeding 21 million. III. How does this round of Hong Kong stock market differ from the two rounds in May and September last year? May 2024 Market Review The May 2024 market was mainly driven by a reallocation of foreign capital in the Asia-Pacific region, based on fund logic. Since the concentration of foreign capital withdrew from AH shares in August 2023, capital in the Asia-Pacific region mainly flowed to Japan. At that time, the market bet on Japan.The dual appreciation of the Japanese stock market and the yen after the normalization of monetary policy. However, this logic was proven wrong after the Bank of Japan raised interest rates at the beginning of 24. The yen depreciated further, with the largest depreciation among major non-US currencies. As a result, some capital flowed back to Hong Kong in April-May 24, leading to the Nikkei index falling behind developed markets since the Japanese interest rate hike on March 19, while Hong Kong stocks led the gains. Therefore, this round of increase is not closely related to fundamentals, and after the rapid rise of Hong Kong stocks, it turned into a continuous decline.2024 September market review The market in September 2024 was mainly driven by the unexpectedly strong reforms in the Chinese capital market, falling under the macro policy logic. The package of policies released on September 24 directly boosted the economy and capital markets, far exceeding expectations. The policies reiterated during the Central Political Bureau meeting on September 26 further ignited the market. By the end of trading on September 30, the Hang Seng Index had broken through 21,000 points. However, on the first trading day after the end of the National Day holiday, the Hong Kong stock market experienced a significant pullback, as market sentiment gradually returned to rationality. The main reasons were 1) tightening liquidity abroad. Stronger-than-expected growth in the US September non-farm employment and CPI data led to stronger US bond yields and the US dollar index, driving foreign capital out of Hong Kong stocks. 2) Hong Kong stock market exhibits clear institutional characteristics, with low acceptance of thematic trading. Foreign and local institutional investors in the Hong Kong stock market accounted for around 35% and 20% respectively, leading to a significant decrease in trading enthusiasm after the overall market situation faded. Review of this round of market trends DeepSeek brings a major breakthrough in the field of AI in China. On January 20, 2025, the DeepSeek-R1 reasoning model was officially released. As an open-source model, DeepSeek's performance is comparable to OpenAI's o1, especially excelling in tasks such as mathematics, coding, and natural language reasoning. In addition, its pricing is highly competitive, with an API price only 3.7% of OpenAI o1's price, with just 16 yuan per million output tokens, far below OpenAI's 438 yuan. With high performance and low cost, coupled with accelerated information dissemination during the Spring Festival, DeepSeek continues to attract market attention. From the trend in user volume, app downloads continue to grow, with daily iOS downloads approaching 300,000. Starting from January 26, DeepSeek has consistently ranked first on China's overall and application charts (free charts). This round of market trends demonstrates positive sentiment in the domestic artificial intelligence sector and strong confidence in future AI development. Firstly, the rapid implementation and application of technology by companies such as Tencent, Alibaba, KINGDEE INT'L in the tech sector drive market sentiment higher, leading to positive investor expectations for the future. Secondly, the reassessment of the value of Chinese tech assets in global markets, continuous inflow of southbound funds, and positive outlook from foreign investors further accelerate the rise of Hong Kong stocks. 4. Did foreign investment participate in the recent rise in Hong Kong stocks? How do we see foreign capital in the future? Foreign capital did participate. From the USD to HKD exchange rate, it can be seen that the HKD exchange rate has gradually strengthened since the end of January, which coincides with the release of DeepSeek. Additionally, the short position ratio on Hong Kong stocks, which can better represent the sentiment of foreign hedge funds, also dropped at the same time. Recent opinions from major foreign investment banks on the Chinese region have also turned positive at the same time. The role of foreign capital in Hong Kong stocks is mainly pulse-like. As seen in the market trends in May and September last year, it is evident that foreign capital quickly flows in for short periods due to certain reasons, but once the logic reverses, hedge funds continue to sell. With greater uncertainty in international relations facing foreign capital after Trump's administration, any macro-level black swan events in the future could change the attitude of foreign capital, making it unsuitable as a fundamental of the funding situation in the Hong Kong stock market. 5. Did southbound funds participate in the recent rise in Hong Kong stocks? How do we view the southbound funds in the future? Southbound funds have increased their participation in the recent rise of Hong Kong stocks, showing a trend of continuous accumulation. Since the beginning of the year, southbound funds have accumulated a net purchase amount of 152.191 billion Hong Kong dollars, a substantial increase compared to the same period last year. Recently, southbound funds in the Hong Kong stock market still maintain a strong overall trend of net inflows. As of February 18, the daily net inflow amount reached 22.4 billion Hong Kong dollars, making it the largest single-day purchase day in nearly four years. The inflow of southbound funds shows a certain structural pattern, with main purchases focused on dividend and internet sectors. Looking at the industry allocation of funds, the preference for dividend sectors has continued in the past month, with a net inflow of 16.4 billion Hong Kong dollars in the banking sector, accounting for over 25% of the total inflow. Key stocks in this sector include Industrial and Commercial Bank of China, China Merchants Bank, Bank of China, among others. Looking at the net inflow situation of individual stocks, there is a concentration on leading technology companies. BABA-W received the highest amount of fund inflows, with a net purchase of 9.504 billion Hong Kong dollars in the past month, followed by Semiconductor Manufacturing International Corporation, TENCENT, LENOVO GROUP, and other companies showing significant inflows. Southbound funds will continue to be an important driving force for the rise of Hong Kong stocks. Firstly, the difference in funding costs between domestic and foreign capital provides a basis for the inflow of southbound funds. Domestic interest rates remain at low levels, while the US maintains high interest rates, leading to a high yield difference between Hong Kong stocks anchored to Chinese bonds and those anchored to US bonds. Therefore, domestic capital is more inclined towards Hong Kong stocks compared to foreign capital. Secondly, considering the high probability of a slowing pace of interest rate cuts in the US this year, it is expected that this phenomenon will continue for a long time. On January 29, the Fed's FOMC meeting announced the maintenance of the benchmark interest rate at 4.25-4.5%, consistent with market expectations. The statement at this interest rate meeting showed some changes: in terms of inflation, the mention of progress towards the committee's 2% target was removed; in terms of employment, the phrase "still at a low level" was changed to "stable at a low level in recent months," indicating a stable labor market. Overall, it is expected that the Fed will adopt a more cautious rate-cutting path in the future. Overall, against the backdrop of the current differentiation in interest rates between China and the US, the willingness of foreign capital to invest is lower than southbound funds, making southbound funds the most important source of incremental funding for Hong Kong stocks. 6. Is the recent rise in Hong Kong stocks close to its peak in the short term? The current round of recovery has entered the middle stage, and attention from investors in the second half may gradually shift from technology stocks to value stocks. Firstly, the catalysis of the AI industry will be the main driving force. As mentioned earlier, this round of gains in Hong Kong stocks is mainly driven by external macroeconomic uncertainties.In the context of large qualitative background, the start of the rebound market is mainly driven by the catalysis of the AI industry, so both domestic and foreign funds show a strong preference for Hong Kong technology stocks, with a large amount of funds pouring in. However, as the favorable factors of the industry gradually fade, market sentiment will also gradually cool down, and market trading volume will tend to decline. Secondly, the recent release of US CPI and employment data, and the domestic economic and financial data exceeding expectations have shifted investment focus. With the two sessions approaching, the logic of the value sector in the Hong Kong stock market is beginning to show, and currently the trading activity in the technology sector of the Hong Kong stock market is already high, the attention of subsequent funds may shift from technology stocks to value stocks. This can be seen from the relative advantage of the Hang Seng Technology/Hang Seng Index. After the end of the catch-up in the value sector, the current rebound of Hong Kong stocks will likely peak.Seven, which sectors will relatively resist the decline if the short-term peak of Hong Kong stocks occurs in the future? We believe that dividend stocks and Internet NETDRAGON are likely to show good defensive performance in the event of a short-term peak in the Hong Kong stock market. Firstly, dividend stocks are expected to perform well as the current domestic low interest rate environment will be maintained for a long time, leading to higher Hong Kong stock yields anchored to China bonds. Secondly, Internet NETDRAGON, even excluding the catalyzing effect of AI industries, has already significantly improved its existing business. Considering that signs of economic recovery are just beginning to appear at the moment, overall market profit improvement in the Hong Kong stock market will not be particularly fast. With a high degree of institutionalization in the Hong Kong stock market, performance is given more importance. Therefore, in the short term, if Hong Kong stocks reach a peak, dividend stocks and internet stocks with large performance advantages like NETDRAGON are likely to resist the decline relatively. Eight, has the bull market in Hong Kong stocks been established in the long term? The long-term bull market in Hong Kong stocks was established in the fourth quarter of last year, and the current trend is a continuation of the bull market. On an annual basis, following the bear to bull market transition since the fourth quarter of 2024, the central trend continues to move upward. The three major long-term cycles in the Hong Kong stock market are currently in a state of bottom recovery, indicating that the bull market will continue. 1) Liquidity cycle: Global loose policies are still ongoing. Since the mid-2023, seven major central banks worldwide have successively entered a rate-cutting cycle, with the current rate-cutting cycle roughly midway. The overall tone in the next 1-2 years is expected to continue to be loose. Currently, the Federal Reserve, influenced by strong economic data, may slow down the pace of rate cuts, but the direction of interest rate policy adjustment will not reverse; Europe continues with a rate cut pace. With domestic rates continuing to reach new lows, there is still a lot of capital flowing into Hong Kong stocks through the Stock Connect dividend scheme. 2) Valuation cycle: Risk premium adjustments and safety margins provide support without significant pressure. After experiencing a 3-year bear market, Hong Kong stock valuations were extremely cheap, and they are still at historically low levels. Even after half a year of consecutive recovery, the P/E or P/B percentiles of most major indices still remain around 30%. Overall, the ten-year percentiles for the P/E and P/B of the Hang Seng Index are at 30% and 20% respectively. 3) Earnings cycle: Currently in the phase of bottom recovery. The earnings cycle of Hong Kong stocks is significantly influenced by domestic fundamentals, and currently, China is still in a state of policy stimulus but with a weak economic recovery, without clear signs of improvement. However, with continuous policy stimulus, there is a certain level of repair in the overall profit cycle, indicating that there is still considerable upside potential in the Hong Kong stock market.