China Securities Co., Ltd.: Why is the Hong Kong stock market clearly underperforming other Asian stock markets this year?

China Securities Co., Ltd. released a research report stating that since 2026, Hong Kong stocks have significantly underperformed other Asian stock markets, facing three main pressures: on the numerator side, the downgrading of earnings of heavyweight stocks. Profit expectations for industries such as internet platforms and automotive chains have been significantly downgraded, while the upward revision of earnings for hard-tech companies cannot offset this. On the denominator side, the constraints of the US dollar and US bonds in the offshore market have led to continuous outflows of foreign capital. At the micro trading level, in the third quarter, Hong Kong stocks faced disturbances in liquidity supply due to IPOs and unlocking. The company is optimistic about the long-term attractiveness of Renminbi assets globally, therefore having stronger confidence in Hong Kong stocks as well. However, for Hong Kong stocks to shift from underperformance to strength, three conditions need to be met: 1) Improvement in the global liquidity environment; 2) Halt in the downward revision of profit expectations; 3) Weakening of micro supply disturbances. If only one of these three pressures is met, the market is more likely to experience valuation adjustments or temporary rebounds; if two begin to reverse, Hong Kong stocks will have a basis for revaluation; if all three resonate, Hong Kong stocks could transition from being discounted offshore assets to trend-oriented assets. The main points of China Securities Co., Ltd. are as follows: 1. Hong Kong stocks have relatively underperformed this year due to a weakening of liquidity and corporate earnings: Since 2026, there has been extreme differentiation in the performance of global emerging market stocks, with Hong Kong stocks underperforming relatively. As of June 10, the comprehensive index of South Korea has risen by 83.45%, the Kechuang 50 has risen by 21.50%, the Hang Seng Index has fallen by 5.60%, the Hang Seng Technology has fallen by 15.30%, and the Indonesia comprehensive index has fallen by 31.14%. Risk assets are not uniformly rising or falling, and behind the differentiation is a clear logic: the higher the weight of AI hardware-related component stocks, the stronger the performance. Among the component stocks of the comprehensive index of South Korea, the proportion of AI hardware-related stocks' market value is 66.8%, for the Nikkei 225 it is 39.1%, and for the Kechuang 50, the proportion of hardware-related stocks is 78.3%. The proportion of AI hardware in the Hang Seng Technology is only 14.48%, the Hang Seng Index only has 2.35%, the Shanghai Index has 3.70%, and indices of Brazil, Mexico, Vietnam, Indonesia, among others, are almost at 0. At the numerator level, which is also the most important reason: currently, tech stocks in Hong Kong are still mainly focused on applications, and the contribution of AI to performance is not yet significant. Furthermore, technology companies in Hang Seng Technology and Hong Kong stocks are not purely technological assets, but are closer to high-volatility assets in the offshore market environment, and their ups and downs are influenced by multiple factors such as industrial narratives, profit expectations, USD liquidity, and passive fund rebalancing. With the pricing of the AI industry switching from application imagination to hardware profit realization, and with the lack of AI hardware-heavy components in the Hong Kong stock index, momentum driven by risk appetite is more likely to turn into a retreat. On the denominator side, the obvious factor is funds: foreign capital has been continuously flowing out of the Hong Kong stock market, and the increase in Hong Kong Stock Connect support for incremental Hong Kong stocks has also significantly weakened. Since the beginning of the year, foreign capital has been reducing positions in Hong Kong stocks. Against the backdrop of a fluctuating USD, global risk aversion is increasing, and the downward revision of profit expectations is reducing the attractiveness of foreign capital valuations. Geopolitical disturbances, coupled with Hong Kong's special pricing mechanism, have prompted some foreign funds to redistribute their holdings to other emerging markets. At the same time, the support from the Hong Kong Stock Connect for incremental Hong Kong stocks has significantly weakened, with the net inflow total size this year being much lower than in the same period in 2024. Hong Kong stocks are not a preferred asset for both A-share and overseas funds, but rather tools for portfolio enhancement. Once US dollar liquidity converges or profit improvement is insufficiently verified, incremental funds are more likely to shift to other markets with higher certainty. 2. The weakness of the Hong Kong stock index is mainly due to the relatively low content of hard technology and the inevitable downgrading of earnings concentration of heavyweight stocks: The low content of AI hardware translates into relatively weak profit expectations compared to other emerging countries. According to Wind's consistent expectations, from January to today, the total earnings forecast for the constituent stocks of the Hang Seng Technology Index has decreased from about 700 billion RMB in 2026 to about 600 billion RMB, while during the same period, the profit expectations for major indexes in South Korea and Japan have been significantly raised, forming a sharp contrast with Hong Kong stocks. The impact of the downward revision of earnings of heavyweight stocks on the earnings expectations of the Hong Kong stock index is particularly prominent. The high concentration of the Hong Kong stock index, where a few internet platforms and automotive chain companies contribute significantly to the index, has seen a major downward revision in performance for these companies this year. While hard technology companies support profits, the magnitude of the downward revision of profit expectations for internet and automotive companies exceeds that of hard technology companies. In fact, there are structural opportunities within Hong Kong stocks, but they are more limited by the drag from weighted industries at the index level. Industry differentiation directly reflects the switch in China's economy from old to new dynamics: raw materials and some resources benefit from global supply constraints and price resilience, while information technology, telecommunications, and internet platforms rely more on needs such as advertising, cloud, AI applications, local life, and consumer services, the recovery of demand on the application side still needs to be verified. 3. Under the triple constraint of USD appreciation, high US bond yields, and a relatively strong Renminbi exchange rate, capital in Hong Kong stocks has experienced an outflow: As an offshore market, Hong Kong stocks are one of the most sensitive markets to liquidity globally. The average daily trading volume of A-shares is typically in the range of 20 to 30 billion RMB, while the normal daily trading volume for Hong Kong stocks is only 20 to 30 billion HKD. The significant difference in liquidity between the two markets further affects the pricing efficiency of individual stocks. Explaining Hong Kong stocks cannot be solely based on cheap valuations, but rather it is important to first determine whether global liquidity is sufficient to support the discounting of valuations. In the scarce liquidity of offshore markets, assets are often not fully priced, and when fundamentals improve, they are easily extrapolated linearly to overvalued levels, and when fundamentals deteriorate, they are easily sold off and undervalued. The first constraint on liquidity comes from the appreciation of the US dollar. Since the beginning of the year, the US dollar index has been fluctuating between 95 and 105, continuously exerting pressure on Hong Kong stocks. Historical experience shows that during phases of USD appreciation, Hong Kong stocks tend to perform weakly because a stronger USD often corresponds to global liquidity convergence, outflows of funds from emerging markets, and pressure on the valuation of risk assets. The second constraint on liquidity comes from high US bond yields. Since the beginning of the year, the yield on the ten-year US Treasury bond has been fluctuating upwards, impacting Hong Kong stocks in three ways: first, high yields suppress the valuation of future cash flows of internet platforms, innovative pharmaceuticals, software services, and new energy vehicles; second, high US bond yields enhance the risk-free return of US dollar assets, leading global funds to demand a higher risk premium for offshore risk assets like Hong Kong stocks; third, high US bond yields are often accompanied by a stronger USD, making it more difficult for funds to flow back into emerging markets. Especially since February this year, with fluctuations in the US-Iran situation and significant fluctuations in oil and gold prices, along with rising US bond yields, the resonance of these three asset classes reflects a short-term re-pricing of expectations for global liquidity. The rise in oil prices implies possible inflation pressures, the rise in gold prices indicates an increase in demand for safe-haven assets, and the rise in US bond yields suggests a delay in rate cuts, all of which are unfavorable for the valuation recovery of offshore risk assets. Behind the rebounds of Hong Kong stocks in 2009, 2019, and 2020, there were shadows of easing global liquidity. The third constraint on liquidity comes from the appreciation of the Renminbi. The temporary strength of the Renminbi further dilutes the actual returns of mainland investors, which is one of the reasons for the marginal slowing down of southbound funds. In terms of HKD pricing, the Hang Seng Index and the Hang Seng Technology Index have fallen by 4.77% and 14.34% respectively; when priced in Renminbi, the declines expand to 8.34% and 17.56%. 4. Micro-liquidity: Disturbances in the supply due to unlocking in the third quarter: In addition to macro factors, Hong Kong stocks are facing micro-liquidity pressures this year. Since the second half of 2025, the size of IPOs in Hong Kong has increased significantly, with the monthly average IPO size for Hong Kong and mainland stocks between 2022 and 2025 being around 7 billion HKD, but since the second half of 2025, this number has consistently exceeded 10 billion, with a slight decline in May but still remaining above 10 billion. Against the backdrop of tight macro liquidity, downward revisions in profit expectations, and insufficient inflow of foreign capital, the disturbance of new supply has been magnified in the market. In the long run, the absorption of new economy companies by Hong Kong stocks is essentially reshaping the market structure, and the continuous listing of high-quality IPOs is expected to enhance the overall quality of companies. If liquidity improves later on, the supply of new stocks may actually become a carrier for structural upgrades. Corresponding to IPOs is the pressure from unlocking. Newly listed stocks in Hong Kong typically face a lock-up period of 6 to 12 months, and the large-scale issuance in 2025 implies a significant amount of unlocking in 2026. The third quarter of 2026 will see a concentrated unlocking: 297.65 billion HKD in July, 78.94 billion HKD in August, and 476.23 billion HKD in September, totaling over 850 billion HKD, a relatively high proportion of the current market value of Hong Kong stocks. In terms of the unlocking structure, large enterprises are mainly concentrated in industries such as non-ferrous metals, software services, consumer services, and pharmaceuticals. At the individual stock level, ZIJIN GOLD INTL in particular has a large unlocking scale. Large-scale unlocking not only increases market supply pressure but may also impact the valuation of related stocks. The matching of the unlocking pace with market acceptance capacity is worth monitoring. 5. Long-term outlook: The key is the resonance of earnings and liquidity Although Hong Kong stocks are under short-term pressure, the long-term outlook sees the attractiveness of Hong Kong stocks as assets denominated in Renminbi offshores. Hong Kong stocks serve as an offshore pricing window for Chinese assets facing global capital, with valuations deeply affected by USD liquidity, enabling them to have greater elasticity when USD and US bond pressure eases. Regardless of the direction of the US-Iran conflict, from a longer-term perspective, the oil price waves stirred up by historical geopolitical games will eventually calm down, alleviating inflation pressures, and the continuous rate-cutting path of the Federal Reserve, hinting at a significant decrease in pressures from the denominator. Firstly, expectations on earnings are crucial, being the most important variable for capturing Hong Kong stocks transitioning from weakness to strength in the medium to long term. Under the tide of AI, the numerator of Hong Kong stocks leans more towards applications in the AI industry chain, with no significant profit contributions in the short term, but the application side still has opportunities. Internet platforms have users, data, payments, content, e-commerce, local life, and cloud infrastructure; once the commercialization of AI applications accelerates, profit elasticity may be re-priced by the market. In addition to AI applications, commodities benefit from global supply constraints and capital expenditures in emerging markets, pharmaceuticals benefit from the overseas market for innovative drugs and improved research and development efficiency, and manufacturing benefits from the restructuring of global supply chains, all contributing to multiple clues of profit recovery. For the stability of the Hong Kong stock index, a turnaround in profit expectations is needed, which could come from three directions: 1. The halt in the downward revision of profit forecasts for major platform companies, with advertisement, games, local life, and cloud businesses recovering. 2. The easing of loss pressure on automobiles and consumer technology, with price competition shifting from disorderly to rational. 3. The contribution of AI applications, innovative drugs, commodities, and manufacturing to new profit upticks. The bottom line of Hong Kong stocks is supported by low valuations, long-term allocation of southbound funds, and the increasing influence of Renminbi assets, but the completion of expected rebalancing will require time due to profit downgrades, high USD and US bond levels, unlocking disturbances, and foreign capital outflows. In terms of structure, in the short term, focus on directions with stronger earnings resilience, more stable cash flow, and lesser disturbance from unlocking; in the medium term, focus on commercialization of AI applications, restoration of profit margins for internet platforms, overseas expansion of innovative drugs, pricing of commodities, and manufacturing overseas. The key to the subsequent performance of Hong Kong stocks is not to prove that valuations are low enough but to show that low valuations can be repaired jointly by earnings and liquidity. In the recent past, Hong Kong stocks have been suppressed by downward revisions in profit expectations, high USD and US bond levels, and micro-supply disturbances. If two of these three pressures begin to reverse, Hong Kong stocks will have a basis for revaluation; if all three pressures reverse simultaneously, Hong Kong stocks can move from catching up to a trend-oriented market. Risk warning: The sustainability of consumption recovery remains uncertain. Since the beginning of the year, consumer spending has started to pick up, but the recovery level is limited. Whether it continues to stagnate at low levels or can continue to approach normal growth rates still needs to be closely monitored. If consumption remains sluggish, the momentum of economic recovery will be limited. The uncertainty of whether the real estate industry can continue to improve. This round of downward cycle in real estate has been going on for a long time, with a temporary warming trend currently seen, but many indicators are still showing negative growth. Whether this warming trend can be maintained still needs to be observed. There are risks due to the availability of incomplete data, the risk of measurement errors due to model failure, and data statistical errors. The impact of tighter monetary policies in Europe and the US may be more pronounced than expected, dragging down global economic growth and asset prices. Geopolitical conflicts remain uncertain, disrupting global economic growth prospects and market risk appetite.