Goldman Sachs expects the second half of the year to continue to be dominated by structured market trends. It is recommended to focus on dividends, technology, overseas expansion, and new consumer trends.

CICC released a research report stating that the performance of Hong Kong stocks in the first half of 2025 is "noteworthy", not only significantly outperforming A-shares, but also holding up well in the global market, showing unexpected resilience even in the face of the significant impact of the "equivalent tariff". However, Hong Kong stocks also have their own "issues": first, since the beginning of 2024, every rebound has been impulse-like, with highs followed by declines; second, performance is overly concentrated in a few industries or even individual stocks, with only 35% of stocks outperforming the index since the beginning of the year. CICC estimates that the earnings benchmark growth rate in the Hong Kong stock market this year is 4-5%, with a 30% tariff dragging down earnings growth by 2 percentage points to 2%, and limited valuation space. In the benchmark scenario, current sentiment has recovered to the level of early October last year. If earnings do not downgrade but also do not receive additional boosts, the corresponding Hang Seng Index would be between 23,000-24,000. In an optimistic scenario, assuming sentiment recovers to the high point of early 2021 (indicating significant progress in tariffs and a reemphasis on technology narrative), earnings realize growth of 4-5%, corresponding to the Hang Seng Index around 25,000-26,000 points. Furthermore, in a pessimistic scenario, if market sentiment returns to the low point of the previous US-China trade friction, corresponding to a 7.7% risk premium, with earnings growth falling to zero (due to sluggish tariff negotiations and insufficient domestic policy efforts), the corresponding Hang Seng Index would be around 20,500 points. In terms of industries, structural market trends remain dominant. CICC recommends focusing on dividends, technology, overseas expansion, and new consumption, over-weighting banks, telecommunications, technology hardware, media and entertainment, new consumption, biotechnology, and standardizing materials, utilities, and essential consumption, while under-weighting energy, real estate, and certain industries. CICC's main points are as follows: Outlook for the second half of the year: From credit cycle recovery to stagnation, from "deleveraging" to "stabilizing leverage" In the past few years, the accurate judgment of several key points in the Hong Kong stock market (such as the high point in October 2024, the high point in early 2025, and the bottom after the equivalent tariff) was mainly due to a firm grasp of the "credit cycle," the lever that determines economic and market trends, judging which factors are more important to the credit cycle, and whether emerging macroeconomic policies, industry trends, and external changes can affect the direction of the credit cycle. The core "dilemma" facing the Chinese economy at present is still the continued credit contraction in the private sector, and the root cause of this situation is not a lack of money or an absolute low level of interest rates. On the contrary, 1) as of April, China's M2 reached 325 trillion RMB, 2.4 times GDP, not only a historically high scale but also historically high compared to GDP; 2) total savings by residents are continuously increasing, with 145 trillion RMB in savings as of April, also historically high; 3) interest rates are not only at historic lows but are also close to the lowest globally, with current 1-year fixed deposit rates at 0.95% and 10-year government bonds at 1.65%, slightly higher than Japan's 10-year bond rate of 1.48%. Therefore, the judgment that residents will invest "excess liquidity" in consumption and the stock market based solely on the scale of savings has been proven ineffective and useless in recent years. The core issue is that the expectations of returns for residents and businesses remain lower than the cost, with the focus on the gap rather than the absolute level. For example, the sustained monetary easing in recent years has lowered housing costs for residents to below 3%, significantly lower than the 6.5% in America, yet this level is still not low enough, especially in the face of average rental returns of less than 2% in first-tier cities, explaining why each rebound in the real estate market in recent years has been unsustainable. From a holistic economic perspective, the actual interest rate (2.2%) as a cost is still lower than the natural interest rate as a return (0.6%), with a gap of 1.6 percentage points, even greater than the gap in the US (0.8 percentage points). The solution lies in two areas: raising return expectations and lowering financing costs. However, due to low interest rates and excess liquidity, the marginal effect of interest rate cuts is decreasing, making it more effective to raise return expectations. Yet, achieving this independently by the private sector (such as through wealth effects) is difficult, necessitating external intervention (fiscal measures reaching the demand side) or the emergence of new growth points (AI technology or new consumption). From this perspective, it is easy to understand the performance pattern of the market in recent years: 1) on the one hand, the stability and rebound of the market, with continuously rising bottoms, are due to these positive changes (focused fiscal stimulus post-924, AI surge driving investment post-Chinese New Year), showing a halt in the contraction of private sector credit. 2) However, on the other hand, the market repeatedly falls after reaching highs, not only due to excessive expectations but also due to policies being "reserved" preventing a complete exit from the credit contraction, with policies slightly easing (slower fiscal stimulus speed post-end of last year), leading to a decline in private credit once again. This also demonstrates that expecting policies to permanently solve the credit contraction issue in the face of multiple "real constraints" is not realistic (our calculations indicate that an additional 6-8 trillion RMB in fiscal spending is needed to bridge the current output gap in one go). Three key factors determine the direction of the Chinese credit cycle: tariffs, fiscal policies, and AI. One perspective in predicting the direction for the second half of the year is to observe the relative changes in these three factors. The high point of fiscal expectations was September 24th, the high point of AI expectations was early this year, and the high point of tariff expectations is currently at 10%. It is not easy for the second half of the year to present a more optimistic situation than these previous high points, for reasons such as: 1) the temporary reduction in tariffs has reduced the urgency of fiscal stimulus. We calculate that the current 30% additional tariffs (20% on fentanyl and 10% equivalent tariffs) have a minimal impact on GDP, requiring only 1.2-1.5 trillion RMB in additional spending to offset, which can be covered by the 2.1 trillion RMB in additional spending planned during the "Two Sessions" this year. Even if there is further escalation, it may only occur after the exemption deadline on August 12th at the end of the third quarter; 2) it is worth observing whether tariffs can improve beyond the current 10%, otherwise restrictions on industry chains and re-export would be unnecessary, especially focusing on whether certain Southeast Asian countries impose additional re-export restrictions; 3) while AI is still burgeoning, it has calmed down considerably compared to its surge post-Chinese New Year, making it difficult to foresee a more optimistic situation in the future. It awaits catalyzing through breakthrough model iteration or groundbreaking application landing.Therefore, from the credit cycle perspective, it is clear that the current situation is no longer a unilateral "deleveraging" credit cycle downturn before the third quarter of 2024, but it has not yet entered the stage of significant expansion of "leveraging up". After experiencing a recovery since the end of last year, the current situation has temporarily stagnated again, and the second half of the year may maintain a volatile "stabilization of leverage". Market and allocation implications: Excessive liquidity "fund abundance" + limited returns "asset shortage" = overall index volatility + structural opportunities The "limited force" of policies and the "partial drive" of technology and new consumption make it unlikely for the credit cycle to shrink again but also difficult to overall restoration, manifested as the "dualization" of demand and prices, such as the heat of new consumption and the weakness of real estate and traditional consumption, the heat of the sinking market and the weakness of first-tier cities, local inflation and coexistence of overall price decline, etc. The same applies to the market and assets, with excessive liquidity "fund abundance" and limited returns "asset shortage", inevitably leading to a lack of trend opportunities in the overall index and range-bound volatility. However, structural trends are prevailing, as seen in: 1) deposits, government bonds, gold, and dividends that provide stable returns and preservation of value continue to be popular with investors, even as fixed returns such as deposit rates, government bond rates, dividend yields continue to decrease; 2) technology growth and new consumption sectors that provide growth returns are becoming more expensive in valuation, with their stock returns also continuously decreasing; 3) other assets with no returns or shrinking attention, such as cyclical, resource, and real estate sectors. Essentially, investors are all pursuing "returns", either stable returns or growth returns. Sectors that have performed well this year, such as new consumption, technology hardware, software services, and media entertainment, all have improved ROE. Meanwhile, dividend sectors like banks, telecommunications services, and utilities at least need to maintain stable ROE, while sectors with declining ROE such as building materials, oil, and coal may struggle to even fulfill dividend roles. This kind of market is not uncommon in history, as seen in the Chinese market from 2012 to 2014 and 2019 to 2020, and the Japanese market from 1992 to 2000, providing opportunities for trend trading in the overall index and structural opportunities aligned with industrial and economic trends. The best strategy to deal with this market is: 1) actively invest during the downturn (have a bottom line), but take profits moderately when excited (prevent overextension); 2) focus on structural opportunities, which have been consistently successful over the past year. How to measure whether it is a downturn or excitement? An effective framework is the weighted risk premium. We calculated that with a profit benchmark growth rate of 4-5% in the Hong Kong stock market this year, a 30% tariff or drag on profit growth of 2ppt to 2%, and limited valuation upside. In terms of points: 1) under the benchmark scenario, sentiment has recovered to early October last year, if profits do not decline but also do not get additional boosts, this corresponds to the Hang Seng Index 23,000-24,000; 2) under the optimistic scenario, assuming sentiment recovers to the high point in early 2021 (meaning significant progress in tariffs and a strengthening of the technology narrative), with profit cashing in on a 4-5% growth, this corresponds to the Hang Seng Index around 25,000-26,000 points; 3) under the pessimistic scenario, market sentiment goes back to the low point of the previous Sino-US trade friction, corresponding to a 7.7% risk premium, profit growth drops to zero growth (tariff negotiations are stagnant, and domestic policy actions are not timely), corresponding to around 20,500 points on the Hang Seng Index. Industry-wise, structural trends continue to dominate, and we recommend focusing on dividends, technology, overseas expansion, new consumption, and biotechnology, while being underweighted in energy, real estate, and some industrial sectors. What are the comparative advantages of Hong Kong stocks? Structural and liquidity changes in the Hong Kong stock market The macro and market environments in China still require adjustment but have structural bright spots, making Hong Kong stocks more advantageous. This is because whether it is providing stable returns from dividends or focusing on structural opportunities such as new consumption, AI technology, and even innovative drugs, Hong Kong stocks have a competitive edge, explaining their outperformance. At the same time, the contradiction of surplus liquidity domestically but a lack of good assets has driven continuous inflows of southbound funds, as long as this "contradiction" remains, there is still long-term demand for domestic funds to be allocated. We estimate that the relative certain southbound incremental funds this year will be 200-300 billion Hong Kong dollars, with a total inflow for the year possibly exceeding a trillion Hong Kong dollars. However, in the context of the US-China game, expecting a substantial return of long-term foreign capital, especially European and American funds, is unrealistic. Still, trading funds and regional funds are willing to allocate to quality stocks. This has to some extent contributed to the structural changes in the Hong Kong stock market over the past two years, on one hand the improvement in liquidity brought by southbound fund inflows and the continuously increasing "marginal" pricing power, on the other hand, more quality companies listing in Hong Kong have helped mitigate the structural imbalance problems in the Hong Kong stock market, attracting more funds to settle. The potential risks of underperformance in Hong Kong stocks mainly come from two aspects: one is a sharp increase in external risks requiring absolute hedging, the other is a massive fiscal effort to boost overall consumption and pro-cyclical strength, neither of which align with our benchmark scenario.