What will be the next step for Hong Kong stocks? Morgan Stanley: Divergence will continue, and foreign capital still has room for allocation

The release of DeepSeek RI and Alibaba Tongyi Qwen2.5-Max has successfully triggered a reassessment of Chinese tech stocks in the global capital markets. On January 13, the first trading day after the release of DeepSeek-R1, the MSCI China Index and the Hang Seng Index rebounded from their lows.

On Thursday, February 13, Morgan Stanley equity strategists Wang Ying and Liu Ying released a report stating that DeepSeek is the biggest driving force behind the rebound in the Chinese stock market. So far, southbound capital has contributed the most to this rebound, while foreign long-term investors still have relatively low positions. In the short term, the divergence in performance between AI/tech stocks and non-AI/tech stocks may continue.

Morgan Stanley noted that recently, the Chinese market, especially Hong Kong stocks, has performed strongly, with DeepSeek being the biggest driving factor:

From January 13 to February 7, the Hang Seng Index rose by 12%, with the Hang Seng Tech Index rising by 22%. The MSCI China Index increased by 13%, with the MSCI China IT sector rising by 24%.

However, the issue is that the performance of AI/tech stocks and non-AI/tech stocks is severely divergent, "indicating a lack of a true beta rebound so far":

The adjusted Hang Seng Index (excluding Hang Seng Tech constituents) has performed flat on a parity basis, with a year-to-date return of only 3% on a market-cap-weighted basis, reflecting that the strong performance of the Hang Seng Index is mainly driven by AI/tech-related stocks.

Specifically, Morgan Stanley pointed out that so far, southbound capital has contributed the most, and foreign long-term investors have low positions, leaving room for increased allocation:

Year-to-date, net inflows of southbound capital have been strong, reaching $17 billion, mainly flowing into the IT and communication services sectors, with the average daily net inflow doubling from $420 million in 2024 to $881 million.

Data as of January 31, 2025, indicates that global large long-term investors still hold a relatively low allocation in the relevant sectors, with their underweight positions further increasing year-to-date.

After a long period of limited attention, global investors are beginning to reassess the investability of China in the technology and AI sectors So, how will the Chinese market evolve next?

Morgan Stanley stated that the divergence between AI/technology stocks and non-AI/technology stocks may continue in the short term:

Before the National People's Congress in March, we are in a policy vacuum, and concerns about macroeconomic slowdown may reduce broad beta investment opportunities.

In addition, China's latest breakthroughs in AI, humanoid robots, electric vehicles, and other fields may further prompt government policies to continue focusing on manufacturing and technology capital expenditure expansion, moving away from consumption stimulus.

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