China gold: Can Hong Kong stocks still be bought?

mbergCICC Research Department CICC released a research report stating that the essence of this round of rebound is based on optimistic sentiment towards technology trends. The extent to which this sentiment is factored in and how much "imagination" space is still available in the future are key to answering questions about future market space. CICC believes that 1) the current trend of AI, narrative changes, and revaluation of valuations is correct, but 2) in the short term, it is also important to control the pace, position, and costs. If there is limited expectation of short-term catalysts, and even the risk of policy not meeting expectations and external disturbances increasing, it is better to adopt a short-term observation approach. The short-term Hang Seng Index is maintained at 23,000-24,000, with a optimistic scenario of 25,000. It should be noted that this static calculation does not mean that a breakthrough will necessarily lead to a sharp decline, nor does it mean that a breakthrough will not occur in the short term with the support of funds and sentiment. However, it does mean that as long as the long-term expectations are not realized, the continuous overdraft of optimistic sentiment and the increasing market divergences are probable. Since the end of 2023, Hong Kong stocks have experienced four rounds of rapid rebounds followed by overdrawn corrections, with the phenomenon of a continuously rising bottom (trillions of government bonds at the end of 2023, real estate policies during the May 1st holiday in 2024, the 924 market in 2024, and the market after the Spring Festival in early 2025). This indicates that 1) policy efforts are effective, hence the continuously rising bottom, and even if the market corrects, it does not completely erase the previous declines; 2) however, the market tends to extrapolate its strength linearly, leading to rapid highs followed by overdrawn corrections. Therefore, the best strategy to deal with this situation is to "actively buy low when the market is low, and profit moderately when it is excited", while focusing more on structural markets with fundamental bases and industry trends. On the industry front, structural markets with industry trends in support of technology are the focus in the medium term. However, in the short term, if adjusting positions, one can choose to balance some assets that have underperformed in terms of dividends. Looking long-term, CICC still recommends focusing on four main areas: 1) stable returns (dividends + buybacks, particularly growth companies with high net cash ratios); 2) technology (related to AI computing power and AI applications), such as cloud servers, domestic computing power companies, AIDC, AI application software, smart driving, humanoid Siasun Robot & Automation and consumer electronics, etc.; 3) going global, with a focus on mid-range manufacturing, media, and new retail; 4) new consumption, targeting leading companies that meet current population and consumption habits. Upcoming events to watch for: March financial data for China, March 12th US CPI, March 17th Chinese economic data. Last week, Hong Kong stocks rebounded strongly, hitting new highs again. The domestic government work report and Trump's speech in the US Congress met expectations, alleviating previous concerns about possible lower-than-expected performance. Moreover, progress such as the release of the universal AI Agent product Manus provided new catalysts for the reassessment of technology stocks. After a week of correction, the market rebounded quickly. The Hang Seng Technology Index rose by 8.4%, the Hang Seng Index by 5.6%, the Hang Seng State-owned Enterprises Index by 5.9%, and the MSCI China Index by 6.4%. In terms of sectors, media and entertainment (+11.3%), raw materials (+8.0%), and consumer discretionary (+7.6%) led the gains, while healthcare (-0.1%), transportation (+0.9%), and utilities (+0.9%) lagged behind. Chart: Over the past week, Hong Kong stocks have seen media and entertainment leading gains, while healthcare has declined against the trend. Data source: FactSet, Bloomberg, CICC Research Department Since the Spring Festival holiday, the AI craze has brought about a significant shift in investor sentiment and macro narratives, driving the continuous rise of the Hong Kong stock market. The Hang Seng Index and the Hang Seng Technology Index have accumulated gains of 19.8% and 27.8%, respectively, with valuation expansion contributing 18.0% and 24.1%, while profit has only contributed a small portion of 1.6% and 3.0%. The market's upward trend primarily relies on valuation drive, with optimistic expectations for the future accounting for the majority (reflected as risk premium ERP). Now that we have reached this point, to what extent has the valuation of Hong Kong stocks repaired, and how much room is there for further expansion in the future? Chart: The upward trend of the Hong Kong stock market is mainly driven by valuation. Data source: FactSet, Bloomberg, CICC Research Department I. Where has the valuation of Hong Kong stocks repaired to? Statically, it remains at a historically low level. 1) In terms of vertical comparison, the Hang Seng Index dynamic PE has recovered from 9.1x before the Spring Festival holiday to near the historical average of 10.8x, corresponding to the 61.2% percentile since 2013; the Hang Seng Technology dynamic PE 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 July 2020. Chart: Hang Seng Index dynamic PE has recovered to near the historical average. Data source: FactSet, Bloomberg, CICC Research Department Chart: Hang Seng Technology dynamic PE is still below the historical average. Data source: FactSet, Bloomberg, CICC Research Department 2) In terms of horizontal comparison, the dynamic PE of the Hong Kong stock market remains 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 government bond yield (~1.8%). Although the ratio has declined after the recent market rebound, it is still above the historical average by more than 1 standard deviation. Chart: The dynamic PE of the Hong Kong stock market is still low compared to major global markets. Data source: FactSet, Bloomberg, CICC Research Department Chart: The dividend yield of the Hang Seng Index (~3.2%) is still significantly higher than the 10-year government bond yield (~1.8%). Data source: FactSet, Bloomberg, CICC Research Department 3) On the sector level, there is a differentiation between the old and new economies, with the dynamic PE of the new economy rising to 16.7x, and the old economy rising to 6.1x, both below the average since 2015. Valuations of sectors such as finance and raw materials have recovered to historical averages, while sectors like retail, media and entertainment, and consumer services are still at historically low levels. Chart: Valuations of sectors such as retail, media and entertainment, and consumer services are still at historically low levels. Data source: FactSet, Bloomberg, CICC Research Department Morgan Stanley, Wind, CICC Research DepartmentFrom the perspective of individual stocks, compared to comparable companies, the valuation of Hong Kong stocks is lower than that of major markets such as US stocks. The dynamic PE average of the "Top Ten Tech Giants" in China is 21.9x, lower than the "Top Seven Tech Sisters" in the US at 28.4x. Therefore, from a static perspective, whether comparing horizontally to other assets and markets, or vertically comparing historical trends, even within the sectors and individual stocks of the Hong Kong stock market, the current valuation of Hong Kong stocks is still at a relatively low level within historical ranges. However, if valuation analysis overlooks macro and market environment changes and only focuses on absolute values and percentiles, it may be like "looking for a sword at the spot where you lost it", as the premise for horizontal and vertical comparisons is the assumption of valuation "mean" regression, but history may not repeat itself. Therefore, to make a reasonable judgment on valuation, one needs to find anchors for valuation, especially in conjunction with the current macro and market environment. By establishing a basic framework to explain changes in valuation, an analysis of the reasons for and prospects of recent valuation expansion can be made. II. What has driven the rapid rebound in valuation? Emotion-driven recovery has basically been achieved dynamically Valuation is the final result of various factors such as fundamentals, policies, liquidity, and emotions working together in trading, and can be simply broken down into two parts: financing cost (rf) and Equity Risk Premium (ERP). The former usually uses the 10-year government bond rate as the risk-free rate (taking into account the uniqueness of the Hong Kong stock market, a weighted average of Chinese bonds and US bonds is used as the risk-free rate), while the latter is the sum of other unexplained parts or residual items. For domestic markets such as US stocks and Chinese A-shares, the risk premium consists more of the "domestic premium" composed of macro premium (policies and fundamentals) and micro premium (liquidity and emotions); if it is an offshore market, such as Hong Kong stocks, an additional "country premium" applicable to foreign investors needs to be added. Since the Spring Festival holiday, the Hang Seng Index and the Hang Seng Tech Valuation have grown by 18.0% and 24.1%, respectively, with only a slight contribution of 1.6% from the risk-free rate, with the rest contributed by the fall in Equity Risk Premium (ERP), which is also a direct expression of the optimistic narrative and expectations. Currently, the risk premium of the Hang Seng Index has fallen to 5.7%, close to the market high of 5.4% at the beginning of 2021, and the risk premium of Hang Seng Tech has fallen to 1.6%, below the historical average since July 2020, narrowing the gap with the historical high of 0.3% at the beginning of 2021. Hang Seng Tech consists of only 30 component stocks, with a significant impact from index rebalancing and limited comparability of historical risk premium. Graph: Risk premium of Hang Seng Index has fallen to 5.7%, close to the market high of 5.4% at the beginning of 2021. Data Source: FactSet, Bloomberg, EPFR, CICC Research Department Graph: Risk premium of Hang Seng Tech has also fallen to 1.6%, near the historical average since July 2020. Data Source: FactSet, Bloomberg, Wind, CICC Research Department The reasons for the rapid fall in risk premiums are twofold: 1) Narrative change boosts risk appetite. DeepSeek has sparked market enthusiasm for tech stocks and even overall Chinese assets, with new catalysts such as the release of the general AI Agent product Manus, leading to ongoing improvement in investor sentiment; 2) Accelerated inflow of Southbound funds increases pricing influence on Hong Kong stocks. As an offshore market, Hong Kong stocks' valuation is a consensus expression of domestic and foreign investors. FactSet's bottom-up aggregation of MSCI China's top 100 weighted stocks can be broken down into domestic and foreign ownership, with foreign investors typically requiring higher risk compensation based on the "country premium", which has long suppressed Hong Kong stock valuations. Recently, Southbound funds have flowed in significantly, buying 31.39 billion Hong Kong dollars since the beginning of the year, more than five times the same period last year, with Southbound transactions accounting for around 30%, reflecting a historical correlation between increases in Southbound transactions and the temporary fall in AH premiums, which affects the pricing of Hong Kong assets by mainland investors. Graph: Southbound funds accelerating inflow, increasing pricing influence on Hong Kong stocks. Data Source: FactSet, Bloomberg, EPFR, CICC Research Department Graph: Increase in Southbound transaction ratio accompanying temporary fall in AH premiums. Data Source: FactSet, Bloomberg, Wind, CICC Research Department III. How much room is left for valuation expansion? Dividend sector has 5% relative space compared to A-shares, matching Technology sector with ROE Based on the above valuation analysis framework, short-term changes in risk-free rates are relatively limited, so attention should be shifted to changes in risk premiums. Short-term risk premiums depend on fund attributes such as the continuous increase in Southbound funds transactions, while long-term risk premiums depend on earnings prospects. If earnings can be realized, it may even lead to a situation where the higher the price rises, the lower the valuation. In specific analysis, this round of rebound shows clear structural characteristics. Although recent market trends have become more widespread, the increase in the stock prices and trading activity of tech stocks still exceeds that of other sectors. Therefore, we use a binary method to assess the expansion space in valuations. Traditional sectors: From a dividend perspective, there is still significant room relative to government bond rates in the long term, but the relative space compared to A-shares is 5%. The recovery of traditional sectors depends heavily on macro total policy and the repair of overall economic leverage, which is different from the "924 trend", so traditional sectors still rely mainly on dividend investment thinking. In this round of rebound with technology at the forefront, the support of sentiment and inflow of funds has also led to the rise of traditional sectors, although lagging behind. This further led to the convergence of the AH premium from 141% to 131%, which is below the historical average by 1 standard deviation, indicating a 31% discount of Hong Kong stocks compared to A-shares. Among the 151 companies listed in both mainland China and Hong Kong, the vast majority are state-owned enterprises and traditional sectors, with sectors such as finance, energy, telecommunications, and utilities accounting for about 80% of the market value. The higher discount of Hong Kong stocks means that the dividend yield is significantly higher than that of A-shares. Even considering dividend taxes (H-shares for individual investors at 20%, red-chip stocks at a maximum of 28%; exempt from taxation for holding for 12 months for corporate investors), it is still attractive. This partially explains why mainland Southbound funds continue to favor high dividend-paying Hong Kong stocks, China Telec.The shareholding ratio of OM Corporation and China Shenhua Energy in southbound funds has exceeded 50%. In this sense, when the same company's dividend yield is equal after deducting 20% tax on A shares and Hong Kong shares, that is, when the AH premium converges to 125%, the attractiveness of dividends to southbound investors will be greatly reduced, and the corresponding dividend sector relative to A shares The space is 5%.Chart: A/H premium converged to 131.4, below historical average by 1 standard deviation. Data source: FactSet, Bloomberg, Wind, CICC Research Department Technology sector: Current valuation is basically matched with ROE, more room relies on profit improvement. DeepSeek sparked market enthusiasm for the revaluation of technology stocks, but after a month of continuous rise, are technology stocks still undervalued? It seems so on an absolute level, but considering the current profitability, further expansion requires more realization, otherwise the space is also lacking. Domestic technology stocks did not participate in the global ChatGPT market previously, causing the gap between Chinese technology leaders (Terrific 10, all Hong Kong stocks) and American technology leaders (Magnificent 7) to widen in terms of stock price and valuation performance over the past two years, with dynamic P/E and PEG of Chinese technology leaders only at 17.7x and 1.41x, significantly lower than American technology leaders' 27.9x and 2.58x. Chart: Gap between stock prices of Chinese technology leaders and American technology leaders widened in the past two years. Data source: FactSet, Bloomberg, Wind, CICC Research Department Chart: Dynamic P/E of Chinese technology leaders is significantly lower than America. Data source: FactSet, Bloomberg, Wind, CICC Research Department Chart: Dynamic PEG of Chinese technology leaders is also lower than American technology leaders. Data source: FactSet, Bloomberg, Wind, CICC Research Department However, the high valuation of American technology leaders is supported by profitability, which is a relatively weak point for Chinese technology stocks currently. Looking at this proportion, the valuation seems reasonable: 1) The market value of Chinese technology leaders accounts for 28.9% of all Hong Kong stocks, higher than America's 26.6%, but the net profit share of Chinese technology leaders is only 13.3%, lower than America's 15.7%. Chart: Market value share of Chinese technology leaders in Hong Kong stock market is 28.9%, higher than America's 26.6%. Data source: FactSet, Bloomberg, Wind, CICC Research Department Chart: Net profit share of Chinese technology leaders is only 13.3%, lower than America's 15.7%. Data source: FactSet, Bloomberg, Wind, CICC Research Department 2) ROE and profit margins of American technology leaders are generally higher than Chinese technology leaders. If we assume that the overall dynamic P/E (28.1x) of American technology stocks matches the expected ROE (34.2%), then the overall dynamic P/E (17.4x) of Chinese technology stocks is already somewhat overvalued relative to the expected ROE (16.8%), with reasonable valuation possibly at 15-16 times. 3) At the individual stock level, in comparable company terms, the dynamic P/E mean of Chinese technology stocks is 21.9x, lower than American technology stocks' 34.5x, but the profit margin mean is only 13.2%, also lower than American technology stocks' 28.4%. Therefore, the estimation of valuation expansion space in the technology sector relies more on the improvement of profitability. 1) If we refer to the target valuations of individual stocks by CICC analysts, Chinese technology stocks may have a 15% expansion space, but there are differences among individual stocks. 2) If the expected ROE of Chinese technology leaders can reach 30% or above, then referencing the valuation of American technology leaders could achieve a doubling expansion. However, until profit expectations are significantly upgraded, the valuation expansion of technology stocks still relies on the sentiment boost brought by event catalysts, which was also the reason for the market pause and adjustment earlier. In a situation where static sentiment and technical aspects are overextended, the long-term macro narrative still needs validation but cannot be falsified in the short term. Market uptrend requires continuous catalysis.