CICC: How much power is left in the rebound?

Chinese investment bank CICC has released a research report stating that the opposite of the extreme K-shaped divergence dominated by AI in the first half of 2026 is the weakness of Hong Kong stocks and consumption. Due to structural issues, the broad-based Hong Kong stock index can actually be seen as a larger version of consumption. Conversely, when technology began to fluctuate in July, both the Hong Kong stock market and the Hang Seng Tech Index experienced a rebound, akin to the two ends of a seesaw. Is there a pattern to this recent wave of rebound? Aside from assessing whether there is a bubble in the AI market and its degree of crowding, some bottom signals were also observed in Hong Kong stocks at the end of June. The report indicates that Hong Kong stocks show signals from multiple dimensions of valuation, sentiment, and allocation, clearly signifying the presence of odds and left-side allocation value, especially for absolute return investors. CICC's main viewpoints are as follows: What drives this round of rebound? Forced rebalancing of extremely crowded positions due to the tech slump. Since the bottom at the end of June, the Hang Seng Index has rebounded by 13.2%, and the Hang Seng Tech Index has rebounded by 14.2%. Among these, the laggard sectors in the first half of the year, such as consumer discretionary (26.2%), healthcare (25.2%), materials (17.9%), transportation (14.8%), and media and entertainment (14.7%), are leading the surge. Low valuations (the dynamic valuation of the Hang Seng Tech Index was below one standard deviation of its historical average before the rebound) and low positions (the proportion of Hong Kong stocks held by actively managed equity public funds fell to 2022 levels) provided favorable conditions for the rebound, or in other words, the odds. However, the primary reason for this rebound is still the forced rebalancing of crowded positions following the tech slump. Specifically, Low-position sectors are leading the rebound, such as internet, nonferrous metals, and innovative pharmaceuticals. Since the end of June, the rebound has shown a significant high cut low characteristic, with the internet sector, which has the highest weighting in Hong Kong stocks, being the main line of this round, as the Hang Seng Internet Technology Index has rebounded nearly 25% from its lows. Among these, the e-commerce leaders like Alibaba, Meituan, and JD.com, which are more related to consumption, have rebounded even more significantly, with their gains at one point exceeding 40% from the lows. In comparison, the media and entertainment sector, such as Tencent, also rebounded but not as strongly as the aforementioned e-commerce leaders. Additionally, innovative pharmaceuticals and nonferrous metals are also considerable contributors to the rebound, with increases around 20%. In contrast, leading sectors from the first half of the year, such as optical fiber, copper foil, and large models, have retraced even more than 60%. Sentiment recovery drives the rebound. This round of rebound has been almost entirely driven by valuation, contributing 11% to the 13% increase of the Hang Seng Index and 14% to the Hang Seng Tech Index, with lower contributions from earnings. Further analysis reveals that the valuation recovery is mainly attributed to a risk premium contribution, essentially sentiment. After all, during this period, U.S. Treasury rates continued to rise, with the weighted risk-free rate of Hong Kong stocks (China bonds weighted with U.S. bonds) rising from 3.6% to 3.9%. Southbound flow and active foreign capital rebalancing drive the rebound. Previously, global and domestic public fund positions were extremely skewed toward technology. For instance, the proportion of Hong Kong stocks held by actively managed equity public funds dropped from 22.5% in the first quarter to 15.1% in the second quarter, marking the lowest level since Q3 2022; the proportion of internet stocks fell to historical lows. During the rebound, southbound capital inflows totaled HKD 62.9 billion in July, averaging HKD 2.86 billion daily, comparable to levels in March and April of this year, and significantly higher than HKD 1.29 billion in June and HKD -0.21 billion in May. Since the end of July, overseas capital has also flowed in for two consecutive weeks, marking the first such instance in nearly three months. Conversely, the South Korean and Taiwanese markets experienced capital outflows, reflecting the seesaw relationship of capital. Have issues suppressing Hong Kong stocks been resolved? Underlying constraints remain, with high tech volatility reducing opportunity cost. The report indicates that the weakness of Hong Kong stocks in the first half of the year primarily stemmed from three constraints: 1) The weakening of domestic demand impacting the entire consumption direction, which also includes Hong Kong stocks as a larger version of consumption; 2) The lack of AI hardware in the Hong Kong stock structure, while the internet sector leader NetDragon has lagged in this round of AI, causing it to miss out on this AI theme; 3) A high number of IPOs, high U.S. Treasury rates, and outflows of southbound and overseas funds have further tightened the funding environment. From the above review, it can be found that during the recent rebound, only the third constraint saw a significant improvement, whereas the other two, especially the first constraint, had little change. 1) The first constraint remains unchanged, and consumption cannot be considered the main force of the rebound; 2) The second constraint, while having helped avoid the recent slump in hardware, has not resolved the underlying issue; 3) The third constraint shows a clear improvement, with tech volatility leading to some capital returning, while the cooling of U.S. rate hike pressures following Julys weak non-farm payrolls has also eased. The domestic demand fundamentals remain weak, and the incremental policies from the Politburo meeting are limited, necessitating a September 24 moment. The main reason for the K-shaped divergence between technology and consumption lies in the divergence of credit cycles between enterprises and households, which stems from fiscal policies skewing significantly towards technology without changing the overall volume (the fiscal deficit is roughly the same as last year), coupled with slower recovery in household income and confidence. Therefore, it requires fiscal policy reinforcement focused on consumption to recreate the September 24 moment. However, the Politburo meeting at the end of July signaled limited incremental policies, primarily focusing on the implementation of existing policies. Compared to the six Central Politburo meetings since the September 24 of 2024, the strength of this round of policy reinforcement signals is lower than in the two meetings following the 2024 and April 2025 tariff equivalence. Although efforts may accelerate in Q3, it does not alter the overall fluctuation pattern for the year, which is insufficient to drive broad-based recovery. Recent structural mismatches in technology have become an advantage, but Hong Kong tech stocks still need to prove themselves, necessitating a DeepSeek moment. The lack of hardware allowed Hong Kong stocks to avoid this round of downturn; however, under the overarching trend of the AI industry, Hong Kong technology and internet sectors still need to prove themselves by increasing investment and optimizing models to achieve breakthroughs in AI commercialization and recreate the DeepSeek moment, driving index trends through heavyweight stocks. There is a need to closely monitor the investment progress and performance catalysts of leading stocks. The volatility of technology and crowded positions have led to a rebalancing of funding, and easing Federal Reserve rate hike pressures will also help. Aside from a large number of IPOs and unlockings, the turbulence in tech stocks and the highly crowded positions will prompt some rebalancing by domestic and overseas funds, which is favorable for Hong Kong stocks. Additionally, the weak non-farm payrolls in July have eased the Fed's rate hike pressures, and if the Strait of Hormuz reopening causes oil prices to fall, it could also help suppress U.S. Treasury rates. When can Hong Kong stocks outperform? It often occurs during the rising phase of household credit pulses. This year, the K-shaped divergence between technology and consumption, as well as A-shares and Hong Kong stocks fundamentally reflects the divergence of enterprise and household credit pulses. Conversely, an interesting phenomenon has been observed: in the past decade, whenever Hong Kong stocks significantly outperformed A-shares, it has essentially corresponded with a strengthening of household credit pulses, particularly since 2018, this phenomenon has been more pronounced. The emergence of this phenomenon is primarily related to the market structure of Hong Kong stocks. The Hang Seng Index and the Hang Seng Tech Index have over 70% weighting in domestic demand exposure through internet platforms, e-commerce, new energy cars, and consumer electronics, with index earnings highly correlated with domestic consumption. In the current environment, the continuous decline in household credit cycles explains the underperformance and weakness of Hong Kong stocks. This is also why this institution has repeatedly emphasized that due to the significant exposure of Hong Kong stocks to consumption and high weighting in internet leaders, for sustained rebounds to emerge from the bottom, either a September 24 moment (fiscal stimulus) or a DeepSeek moment (technological breakthrough) is necessary. How to allocate? Compared to the Hang Seng Index, the Hang Seng Tech Index still has odds; beyond technology, balance towards directions with lower fundamental resistance. Since the current rebound in Hong Kong stocks is more characterized by relative attractiveness under the backdrop of high valuations, high crowding, and high volatility in technology, rather than significant upward profit attractiveness, it follows that when valuations and sentiment have returned to average levels, if there is no profit improvement, the odds will naturally decline. In this regard, the odds of the Hang Seng Index, as a broad-based index, are clearly lower than that of the Hang Seng Tech Index. After this round of repair, the valuation of the Hang Seng Index has returned near its historical average, and the valuation gambled previously has mostly been realized, so this institution temporarily maintains its point judgment, indicating a short-term central range for the Hang Seng Index of 26,000-27,000 points. In contrast, the Hang Seng Tech Index experienced a steeper decline earlier, and its current valuation is still at a historically low level, with the odds advantage not having been fully consumed. As U.S. Treasury rates decline, internet leaders catalyze, and funding rebalancing progresses, its elasticity will also be stronger. The latest updated cross-asset and market odds win rate framework reflects this. However, this institution still emphasizes that funding rebalancing and low valuations can only support a phase of rebound and that the odds mindset remains. A sustained broad market rally in the medium to long term still requires fiscal boosts targeting household consumption in a September 24 moment or breakthroughs in internet leading firms during a DeepSeek moment. In terms of industry selection, technology remains the main line. This institution's self-developed AI pressure index approached the peak of bubble concerns observed in April and November 2025 last week, indicating that pressures have reached a historical high, which suggests that under normal circumstances, conditions should not deteriorate further. Recent weekly data has indeed shown some retracement, which is also favorable for the market. Moreover, threefold pressures on AI (high crowding, Federal Reserve implications, and industrial bottlenecks) have partly dissipated, all indicating that the period of maximum volatility in technology may be gradually passing. However, to experience substantial upward movement, new catalysts are still necessary to open up the current demands ceiling, similar to Anthropics breakthroughs in coding in the first quarter. Therefore, aside from technology, moderate balancing towards other directions is advisable to balance odds win rates and prevent excessive volatility exposure in the portfolio. The experience of this severe turbulence in technology has taught this institution that excessive speculation on win rates can lead to significant volatility risks, and thus balancing odds win rates is a more prudent choice. Specific balancing can consider directions with smaller fundamental resistance, such as innovative pharmaceuticals, some internet sectors, and commodities benefiting from falling U.S. Treasury rates. In other words, in comparison to domestic consumption, the certainty around cyclical and external demand is higher. Finally, the latest updated odds win rate framework from this institution indicates that current allocations in insurance, materials, electrical equipment, pharmaceuticals and biotech, and energy sectors have higher overall scores in terms of odds win rates.