CITIC Securities: With the MSCI rebalancing approaching at the end of February, Hong Kong stocks may face profit-taking risks, but it does not change the reversal trend for the whole year

Since January 14 of this year, benefiting from the explosive popularity of DeepSeek and expectations of domestic policies, Hong Kong stocks have continued to rise. However, yesterday at noon, after the Hang Seng Tech Index broke through the intraday high of October 7 last year, Hong Kong stocks experienced an overall pullback. By the close, the dynamic PE of the Hang Seng Index and Hang Seng Tech remained below the historical 30th percentile. In addition, compared to the earnings expectations on February 7 and January 24 (Bloomberg), both the S&P 500 and Nasdaq 100 in the US have been downgraded, while Hong Kong stocks remained stable.

In this context, since January 24, foreign capital has flowed back into the Hong Kong stock market by nearly HKD 13 billion, mainly allocating to technology and consumer sectors with relatively high valuation discounts. Recent short covering has also been one of the main drivers of the rebound in Hong Kong stocks. As of February 7 this year, the overall amount of unclosed short positions in the Hong Kong stock market accounted for 1.37% of the market capitalization, which is more than two standard deviations above the historical average since the beginning of 2023. In the short term, with MSCI rebalancing approaching at the end of February, Hong Kong stocks may face the risk of overseas capital rebalancing. However, looking at the whole year, against the backdrop of a gradual recovery in the domestic economic fundamentals, coupled with the cost-effectiveness of valuations, we remain optimistic about the continuation of the reversal trend in Hong Kong stocks since 2024.

▍Event:

Since January 14 of this year, benefiting from the explosive popularity of DeepSeek and expectations of domestic policies, Hong Kong stocks have continued to rise. However, yesterday at noon, after the Hang Seng Tech Index broke through the intraday high of October 7 last year, it experienced a decline, leading to an overall pullback in Hong Kong stocks. We believe that the decline in Hong Kong stocks at noon was due to investors taking short-term profits, and from a global perspective, the cost-effectiveness of Hong Kong stocks remains significant.

▍DeepSeek emerges, and expectations for the Two Sessions catalyze the surge in Hong Kong stocks since mid-January.

On January 20 of this year, DeepSeek released the R1 model, which significantly reduces the training costs of AI models, and the model's capabilities are approaching those of the latest models from leading US AI companies. Combined with the rapid deployment of related AI models by Chinese companies and news of cooperation between Alibaba and Apple, it demonstrates a good interaction between the domestic AI training and application sectors. At the same time, global investors have begun to doubt whether the massive capital expenditures of US tech giants in the AI field can deliver results. Additionally, as we approach March, the policy expectations for the national Two Sessions have begun to reflect, further supporting the sentiment in the technology and consumer sectors of Hong Kong stocks. From January 14 to February 12, the Hang Seng Index and Hang Seng Tech rose by 14.1% and 25.1%, respectively. In terms of industry, information technology (26.2%) and discretionary consumption (22.7%) led the gains.

▍US tariff increases continue to take effect, and the Federal Reserve's hawkish stance suppresses US stock performance.

In addition to the impact of DeepSeek's launch on the US tech sector, the tariff policies continuously introduced by Trump since February this year have further suppressed US stock performance, including the 10% tariff on Chinese goods that took effect on February 1, the delayed 25% tariff on Canada and Mexico, and the announcement on February 10 of a 25% tariff on steel and aluminum imported into the US, all of which have put pressure on the earnings expectations for US stocks in 2025 Comparing the performance expectations of U.S. stocks on February 7 this year with those on January 24 (Bloomberg consensus expectations, same below), the net profit and revenue expectations for the S&P 500 in 2025 were revised down by 0.5% and 0.1%, respectively, while the Nasdaq 100 saw reductions of 0.6% and 0.2%. Additionally, the January U.S. CPI reading exceeded Bloomberg's market consensus expectations, and Jerome Powell's hawkish statements during congressional hearings also put pressure on U.S. stocks.

▍With the cost-effectiveness of Hong Kong stocks becoming prominent, foreign capital has flowed back nearly HKD 13 billion since January 24.

Unlike the downward revisions of U.S. stock performance expectations during the aforementioned period, the performance expectations for Hong Kong stocks in 2025 remained relatively stable, and valuations are still at historical lows. As of February 13, the PE ratio of the Hang Seng Index was 9.8 times (historical 28.8% percentile), while the Hang Seng Tech Index, despite reaching a post-pandemic high, had a PE ratio of only 17.4 times (historical 26.5% percentile), which is not only lower than the peak of 19.0 times on October 7, 2024, but also significantly below the peak of 26.3 times on January 27, 2023. The valuations of the Hang Seng Index are also lower than previous highs. Furthermore, from an industry perspective, between 2019 and 2022, the PE levels of Hong Kong and U.S. stocks in the consumer and technology sectors were relatively close, but since then, the valuation premium of U.S. stocks compared to Hong Kong stocks in corresponding industries has continued to widen. Currently, the dynamic PE ratio of the consumer sector in Hong Kong is only half that of U.S. stocks, and the valuation of the information technology sector is over 30% discounted compared to U.S. stocks, making the cost-effectiveness significantly prominent. Since January 24, foreign capital has flowed into Hong Kong stocks amounting to HKD 12.76 billion, coinciding with the timing of the U.S. stock market correction, primarily flowing into relatively undervalued consumer and technology sectors.

▍Although the short-selling ratio has declined, it remains at historically high levels.

In addition to the foreign capital inflow and the net buying of HKD 6.1 billion per day from the southbound trading from the beginning of the year to February 12, recent short covering has also been one of the main drivers of the rebound in Hong Kong stocks. However, as of February 7 this year, the overall amount of outstanding short positions in the Hong Kong stock market accounted for 1.37% of the market capitalization, still at a high level (more than two standard deviations above the historical average since the beginning of 2023). From an industry perspective, the outstanding short ratios are relatively high in healthcare (2.1%), consumer staples (1.8%), and materials (1.5%). Compared to the peak short-selling levels on October 8 last year and January 13 this year, the industries with a larger proportion of short covering are consumer discretionary, materials, and financials. During the same period, the industries with a significant increase in the proportion of short positions are concentrated in the dividend-paying sectors of communication services, utilities, energy, and industries that may be affected by a new round of tariffs.

▍With MSCI rebalancing at the end of February, Hong Kong stocks may face profit-taking risks, but this does not change the reversal trend for the year.

From the last MSCI rebalancing effective date in 2024 (i.e., November 26, 2024) to February 12, 2025, the Hang Seng Index has cumulatively risen by 14.1%, and the Hang Seng Tech Index has surged by 25.1%. During the same period, the MSCI Global Index and Emerging Markets Index have only risen by 1.6% and 2.2%, respectively Reviewing the adjustment period from August to November 2024, the performance of the Hong Kong stock market significantly outperformed the MSCI index (global and emerging markets), but experienced a decline in the first two trading days of the adjustment period's effective date. Furthermore, if the Trump administration announces further tariff increases, there is a risk that the Hong Kong stock market may face profit-taking corrections by the end of February. However, looking at the whole year, against the backdrop of a gradual recovery in domestic economic fundamentals, coupled with the cost-effectiveness of valuations, we remain optimistic about the continuation of the reversal trend in the Hong Kong stock market since 2024.

Authors of this article: Xu Guanghong; Wang Yihan, Source: CITIC Securities Research (ID:gh_fe1d2be7e8db), Original title: "Overseas Research | Hong Kong Stock Strategy: Short-term profit-taking risks, but the reversal trend for the whole year remains"

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