HAITONG INT'L: Fundamentals Are Key to Market Performance; Hong Kong Stocks Likely to See a Rebound in October

HAITONG INT'L released a research report stating that, based on fundamentals, it maintains its judgment that Hong Kong stocks are highly likely to see a rebound in October. Although fundamental repair still takes time, volatility in overseas bond markets has triggered overly crowded pessimistic trades, causing Hong Kong stocks to adjust far beyond what fundamentals would justify. Therefore, a subsequent rebound in Hong Kong stocks may only need short covering to start, and may not require a full recovery in the economy and earnings. Whether the rapid rise in long-end U.S. Treasury yields can end is the key variable for opening up room for a recovery in Hong Kong stocks. Defend and counterattack, basing decisions on fundamentals and responding to all changes by remaining unchanged. At present, among the factors affecting global equity pricing, the rise in long-end U.S. Treasury yields, deteriorating risk appetite, and listed companies' short-term performance have already been fairly fully priced in. However, the market has seriously underpriced the upper limit of long-term sustainable growth for technology companies, that is, their natural growth rate, and this is the real opportunity in the autumn of the AI market. In an era of high interest rates, carefully select fundamentals, tap the main application line of superintelligence, and allocate to deep-value assets outside the technology sector. HAITONG INT'L's main views are as follows: Market Outlook U.S. and European bond market turmoil is unlikely to trigger a crisis; maintain the view that "global stock markets are expected to move from risk off to risk on in October" 1. The U.S. Treasury turmoil will see a turning point, and the rapid rise in the 10-year U.S. Treasury yield in late September is unlikely to last First, the 10-year U.S. Treasury yield recently rose to around 5.3%, fairly fully pricing in various macroeconomic fundamentals for this year. Since May, we have continuously warned of the risk of a "summer cold wind" and regarded the unexpected rise in long-end U.S. Treasury yields as a "gray rhino" facing global risk assets, predicting that it might rise above 5% in the third quarter and reach around 5.3% in an extreme scenario. The market has now moved to this level. Entering the third quarter, this risk has gradually materialized. On September 30, the 10-year U.S. Treasury yield closed at 5.29%, the highest since June 2007, and had risen by a cumulative 91bp since the end of June. The market priced the policy rate at about 4.8% by the end of 2027, nearly 70bp above the median of the Fed's September dot plot, indicating that rate hike expectations have already been priced in quite fully. Second, the main contradiction in the current rise in long-end U.S. Treasury yields has shifted from the level of rates to the speed of the rise. The rise in U.S. Treasury yields to a high level itself has fundamental support such as a relatively strong U.S. economy and relatively strong inflation. What truly deserves attention is the excessively rapid pace of the rise since September. In recent weeks, the acceleration in U.S. Treasury yields has become extreme: the MOVE index rose from 78.6 to 110.45 in late September, and the rate rise shifted from orderly under low volatility to accelerated under high volatility. Since September, the rise in U.S. Treasury yields has gone through two stages: policy repricing and trading-driven amplification. In the earlier period, short-end yields led, real rates dominated, and the curve flattened, which was a typical repricing of the policy path. After September 23, yield movements began to diverge from policy pricing: the probability of a rate hike fell and 2-year yields retreated, while 10-year and 30-year yields continued to rise, and the curve shifted from bear flattening to bear steepening, due to shrinking risk budgets in a high-volatility environment combined with weaker market absorption capacity at quarter-end. Third, the "surge" in U.S. Treasury yields since September is unlikely to last, and turmoil in overseas bond markets is unlikely to evolve into a global financial crisis. We believe in common sense: any sustainable change should be relatively steady, and sustained and violent surges are often difficult to sustain. It is not appropriate to over-search for reasons to justify short-term surges simply because they occur. On the contrary, we maintain our previous judgment the long-end U.S. Treasury yield is likely to fluctuate and pull back from high levels in October. 1) Policy and fundamental conditions are beginning to turn. Weakening employment and widening credit spreads are increasing the probability of downward revisions to policy expectations. September nonfarm payroll gains were significantly below expectations, and high-yield bond spreads widened markedly during the same period. The self-tightening of financial conditions has begun to constrain policy expectations. Historical experience shows that weakening data combined with Fed confirmation that it will no longer tighten is an important scenario in which rates fall significantly after a sharp rise. 2) Trading-driven amplification factors may fade, high U.S. Treasury yields amid high growth are beginning to attract allocation demand, and the U.S. Treasury turmoil is not the European debt crisis of those years. In the short term, as quarter-end passes, trading-related factors may gradually fade. Long-end market absorption has not yet failed. In the September reopenings of 10-year and 30-year auctions, the primary dealer takedown ratio was at a low since 2023, indirect bidders accounted for nearly 80%, and the awarded yields were below the pre-issuance trading yields. Less passive dealer absorption and higher end-investor participation indicate that long-end supply can still be absorbed by the market at current yield levels. In the medium term, the U.S. economy remains relatively resilient, and long-end U.S. Treasury yields may continue to fluctuate at high levels, but this is a high-rate environment matched by high growth. On investment, U.S. Department of Commerce data show that real business equipment investment in the second quarter grew at a quarter-on-quarter annualized rate of 13.4%, continuing the double-digit growth trend of 15.5% in the first quarter. On consumption, real personal consumption expenditures in the second quarter grew at a quarter-on-quarter annualized rate of 3.8%; real final sales to domestic purchasers, covering consumption and private fixed investment, grew 4.6%, significantly faster than 1.8% in the first quarter. 3) The recent turmoil in the European bond market is unlikely to evolve into another European debt crisis or a new global financial crisis. Instead, it may cause European funds to flow into the U.S. Treasury market for safe haven, which in the short term helps push down long-end U.S. Treasury yields. Recently, the European government bond market has seen notable volatility, but performance across countries has been highly divergent. German government bonds still attract safe-haven funds, while pressure is mainly concentrated in countries with tighter fiscal constraints, weaker growth, and rising government bond risk premiums, reflecting a reassessment of country-specific fiscal risk. More importantly, U.S. funding markets and Treasury cash market liquidity indicators remain normal, which, based on history, may become a subsequent safe haven. 2. Fundamentals will be key to fourth-quarter market performance. Against the backdrop of high overseas interest rates and high macroeconomic volatility, investment needs to be based on fundamentals and respond to all changes by remaining unchanged First, differences in fundamentals have recently been fully reflected in equity pricing. Amid turmoil in overseas bond markets, the earnings resilience of U.S. stocks constitutes a winner-takes-all advantage. 1) From the Citigroup Economic Surprise Index, from the end of August to October 2, the United States rose from 17.1 to 37.7, with economic data overall exceeding expectations by a greater degree; the euro area fell from 82.2 to 74.5, still maintaining a relatively high positive level; Japan fell from 67.8 to 19.6, with the degree of upside surprise clearly weakening; China edged down from -33.2 to -35.6, still overall below market expectations, but already repaired from -45.4 in mid-September, with negative surprises easing recently. 2) From the manufacturing PMI perspective, global manufacturing remains resilient, but the pace of repair across economies has diverged somewhat. In September, the U.S. ISM manufacturing PMI edged down 0.1 percentage point to 54.5, while the new orders index instead rose to 55.3, with demand still supporting manufacturing expansion; the euro area manufacturing PMI rose from 52.7 to 52.9; Japan fell from 54.9 to 54.1, still in a relatively high prosperity range. China's official manufacturing PMI rebounded from 49.8 to 50.1, returning to expansion territory. 3) From earnings forecasts, U.S. stock earnings expectations have continued to be revised upward and are stronger, while Hong Kong stocks are gradually emerging from lows, with marginal improvement. The year-on-year growth rate of S&P 500 EPS forecasts for the next 12 months rose from 32.06% at the end of June to 37.61% at the end of September, with earnings support still relatively strong; during the same period, the year-on-year growth rate of Hang Seng Index EPS forecasts for the next 12 months rose for three consecutive months to 6.94%, and earnings forecasts for Hang Seng TECH recovered to 8.89%. Second, roses have spring, and bitter herbs also have spring. For fourth-quarter market performance, focus on fundamental "expectation gaps" and the "cost-effectiveness" of stock market fundamentals and valuations. Based on fundamentals, we continue to be optimistic about the U.S. stock market in the fourth quarter, but after recent record highs, the cost-effectiveness of U.S. stock fundamentals and valuations has declined, and we should be alert to the impact on U.S. stocks in the short term from U.S. Treasury and European yields rising by inertia. Based on fundamentals, we still maintain our judgment that Hong Kong stocks are highly likely to see a rebound in October. Although fundamental repair still takes time, volatility in overseas bond markets has triggered overly crowded pessimistic trades, causing Hong Kong stocks to adjust far beyond what fundamentals would justify. Therefore, a subsequent rebound in Hong Kong stocks may only need short covering to start, and may not require a full recovery in the economy and earnings. Whether the rapid rise in long-end U.S. Treasury yields can end is the key variable for opening up room for a recovery in Hong Kong stocks. Specifically: 1) Hong Kong stocks currently have a relatively large fundamental "expectation gap." Investors examine China's economy and economic policy under a microscope and reach pessimistic conclusions, ignoring the principle that the direction of China's economic policy is definitely more important than any specific policy, and underestimating the ability of policy to ultimately stabilize domestic demand and the economy. What is more worth grasping at present is repair opportunities under low expectations, with subsequent earnings then verifying the sustainability of the rally, which is more consistent with the pricing characteristics of Hong Kong stocks. 2) Hong Kong stocks currently have relatively good cost-effectiveness in earnings and valuation, risk appetite is extremely low, and indicators such as short selling and valuation have reached extreme values. On October 2, the Hang Seng Index fell 2.60%, losing the 24,000-point level. On that day, short-selling turnover accounted for 27.34% of total market turnover, the fifth highest since 2015; the Hang Seng Index's forward 12-month forecast P/E fell to 9.97 times, and the AH premium index rose to 126.77, further widening the discount of H shares relative to A shares. These indicators show that investors have become relatively cautious in pricing Hong Kong stocks, and demand for defense and hedging is also relatively concentrated. 3) Hong Kong stocks are expected to decline first and then rise in October, accumulating strength before making a move. Attention can be paid to Hong Kong stock volatility indicators, U.S. Treasury yield trends, and U.S. stock trends. On the one hand, from historical experience, phased bottoms in Hong Kong stocks mostly appear when the volatility index spikes. The Hang Seng Volatility Index is currently 19.34, not yet significantly elevated. If volatility rises further later, the win rate for a phased bottom will increase significantly. On the other hand, pay attention to when long-end U.S. Treasury yields fluctuate and pull back. Once the external environment stabilizes, the currently concentrated short-selling and hedging trades in Hong Kong stocks may see short covering. If long-end U.S. Treasury yields indeed end their rapid rise in October and gradually pull back as we expect, the external discount rate pressure facing Hong Kong stocks will ease accordingly; with mainland China interest rates relatively stable, the China-U.S. interest rate differential will also narrow, further improving the relative attractiveness of Chinese assets. If volatility in overseas bond markets declines in tandem, the risk compensation required by investors will also fall, which together with lower risk-free rates will drive a valuation repair in Hong Kong stocks. If U.S. Treasury pressure eases, the U.S. stock market may broaden from technology-weighted leaders to a wider range of sectors, also providing further support for a rebound in Hong Kong stocks. (3) Investment strategy: defend and counterattack, adapt to the era of high interest rates and high volatility, tap the main application line of superintelligence, and allocate to deep-value non-technology assets Catalysts for a rebound in Chinese and U.S. stock markets in the fourth quarter: 1. Before the U.S. midterm elections, geopolitical risks cool as expected; 2. The U.S. Treasury market sees a turning point, with long-end U.S. Treasury yields fluctuating and pulling back: watch U.S. inflation and employment data, the FOMC decision and post-meeting statements, and Treasury borrowing estimates and refunding announcements; 3. Applications of U.S. superintelligence continue to spread, while China's economic policy continues to intensify. Investment strategy: defend and counterattack, base decisions on fundamentals and respond to all changes by remaining unchanged. At present, among the factors affecting global equity pricing, the rise in long-end U.S. Treasury yields, deteriorating risk appetite, and listed companies' short-term performance have already been fairly fully priced in. However, the market has seriously underpriced the upper limit of long-term sustainable growth for technology companies, that is, their natural growth rate, and this is the real opportunity in the autumn of the AI market. Investment recommendations: in an era of high interest rates, carefully select fundamentals, tap the main application line of superintelligence, and allocate to deep-value assets outside the technology sector. Main line one: carefully select global technology leaders and capture growth opportunities from application diffusion. In the coming months, industrial growth and valuation repair in technology assets may resonate, providing continued catalysts for Chinese and U.S. technology leaders to strengthen further. For U.S. technology leaders, supply chain stability and an improved financing environment will help advance computing power construction and application commercialization; for Chinese technology companies, technological and manufacturing advantages will further orders and profits. While grasping cross-border cooperation opportunities, medium-term allocation to Chinese technology should still emphasize self-controllability. Chinese technology should balance self-controllability with global industrial demand, continue to emphasize security and controllability, private deployment, and industry adaptation needs, focus on companies with strong technological breakthroughs, practical usability, and commercialization realization capability, and capture the growth space brought jointly by building autonomous capabilities and application diffusion. AI applications will enter a boom, and the value of the AI industry chain is expected to expand further from the mere pursuit of model capability toward security, reliability, and inference applications. 1) The importance of cybersecurity, model governance, and enterprise private deployment will continue to rise. AI security discussions have entered institutionalized coordination at the government level between China and the United States. 2) Pay attention to opportunities brought by the implementation of AI applications in fields such as biomedicine and embodied intelligence. AI applications can promote technological innovation in fields such as pharmaceuticals, intelligent driving, embodied intelligence, and advanced manufacturing by optimizing R&D, production, operations, and service processes. 3) The AI ecosystem is becoming connected, and the combination of sufficiently capable large models and massive application scenarios opens new monetization space for existing traffic, data, and customer relationships. Last week, Meta Muse remained active, further strengthening expectations for AI application commercialization and driving market attention to incremental software and hardware opportunities brought by application diffusion. Similarly, OpenAI will hold DevDay in the early hours of September 30 Beijing time. 4) On the AI hardware side, carefully select opportunities in domestic computing power, semiconductor equipment, advanced packaging, coordination between domestic models and computing power, and coordination between computing power and energy. Demand for building autonomous computing power and models, especially the structural increment brought by growth in inference demand, comes not only from external restrictions, but also from supply stability, data security, industry adaptation, and cost control. Main line two: allocate to deep-value assets and prepare for "enduring" Hong Kong stocks in the era of high overseas interest rates and high volatility. First, in the fourth quarter, we expect the U.S. economy to remain resilient, and long-end U.S. Treasury yields are expected to fluctuate at high levels or even decline somewhat. Market performance in nonferrous metals, power equipment and energy storage, chemicals, and digital assets is worth watching. Second, Hong Kong stocks may receive joint support from a contraction in risk premium and marginal improvement in earnings. On the one hand, carefully select internet and technology leaders with a customer base, application scenarios, and cash flow support; on the other hand, carefully select mainland high-dividend assets, Hong Kong local stocks, and Macau local stocks.