CICC: Reassessing the Outlook for the Revaluation of Chinese Assets

After experiencing a rapid rise triggered by DeepSeek's narrative of re-evaluating Chinese assets in the two weeks following the holiday, the market continued to rise last week, reaching new highs since the beginning of this round of market. Among them, the Hang Seng TECH Index surged 6%, recovering all losses since December 2021; the Hang Seng Index rose 4%, breaking through the high point of last October. In terms of sectors, this week's market continued to focus on the technology industry, with Information Technology (+10.6%), Healthcare (+7.3%), and Media & Entertainment (+6.6%) leading the gains, while Energy (-4.0%), Materials (-3.0%), and Consumer Staples (-0.8%) led the declines.

Chart: In the past week, Hong Kong stocks in Information Technology, Healthcare, and Media & Entertainment led the gains, while Energy fell against the trend Source: Factset, CICC Research Department

However, after a recent continuous rise, if it were not for Alibaba's earnings report on Thursday night, which greatly exceeded expectations and provided emotional continuity, the market showed some signs of "fatigue" in the first half of last week: the overall performance was volatile and declined over the first four days, and on Thursday, the Hang Seng TECH Index once corrected by 3%. Meanwhile, there was also a significant outflow from the southbound trading, indicating a tendency for profit-taking.

In our report last week titled "Re-evaluation of Chinese Assets?", we pointed out that from a static perspective, both sentiment and technical indicators are overstretched. In the current macro narrative, which is long-term pending verification but cannot be falsified in the short term, the market's upward movement also requires continuous catalysts. Last week's Alibaba earnings report happened to play this role; otherwise, the market might have paused. At this current point, we further analyze the following regarding this round of market.

1. How to define this round of market? A sentiment-driven typical structural "bull market"

On one hand, since the rebound began after the Spring Festival (February 3), the Hang Seng TECH Index has accumulated a rise of 24%, entering a technical "bull market" (a rise of more than 20%). On the other hand, the scope of this rise is very narrow, driven only by a few individual stocks in the technology sector, with the rebound foundation far smaller than the 924 round driven by macro total policies. Since the Spring Festival, only about 21% of stocks under the Hong Kong Stock Connect have outperformed the index in this rebound. If we look at the Hang Seng Index, only half (42 out of 83) of the constituent stocks have risen, with 17 outperforming the index (accounting for 21%), while the remaining 41 have declined. This also means: 1) This round of market is highly concentrated, and the index space is essentially determined by the space of a few leading stocks; 2) If one cannot accurately grasp the individual stocks and industry structure, it is difficult to outperform the index in this round of rebound; 3) There is not much dependence on the macro environment, which is the biggest difference from the "924 market" and is also a reason for some investors to be more optimistic to some extent Chart: In this round of market, risk premium contributes the vast majority of the driving force Source: Bloomberg, China International Capital Corporation Research Department

Chart: The market focuses on the technology sector, with companies outperforming the index accounting for only about 20%... Source: Bloomberg, Wind, China International Capital Corporation Research Department

Chart: ...far less than the "924 market" where the outperforming ratio exceeded 60% Source: Bloomberg, FactSet, Wind, China International Capital Corporation Research Department

Sentiment and technical indicators are further overdrawn, with the RSI on the 6th of last week once approaching 90, close to the early October high; the risk premium of the Hang Seng Index has fallen to 5.81, a new low since June 2021; the proportion of short selling transactions has significantly dropped from a high of 18.9% on Tuesday to 13.9%, indicating some short squeeze and position closing behavior.

Chart: The Relative Strength Index (14-day RSI) once broke through 80, reaching a new high since this round of market Source: Bloomberg, China International Capital Corporation Research Department Chart: The proportion of short selling transactions in Hong Kong stocks has declined, with some divergences reduced or forced short covering due to the rise Source: Bloomberg, CICC Research Department

Chart: The risk premium of the Hang Seng Index has quickly fallen to 5.8%, below the level at the market peak in early October last year Source: Bloomberg, Wind, CICC Research Department

In terms of capital flow, the main inflow this week is still primarily from trading and passive funds, although the outflow of active funds has narrowed. This week, passive funds (ETFs) accelerated inflows, mainly focusing on China and Chinese concept funds, which aligns with investors using these two index tools to speculate on the tech market; active funds (mainly LO) continue to flow out but at a reduced scale, focusing on funds that concentrate on China and emerging markets, with inflows mainly from Chinese concept funds. Meanwhile, there has been a significant inflow from the south. This week, southbound funds saw a substantial inflow of HKD 51.21 billion, more than double last week's inflow of HKD 21.77 billion. Currently, the southbound trading accounts for 31% of the total trading volume of Hong Kong stocks, and the market value of southbound holdings accounts for about 10% of the total market value of Hong Kong stocks, with no significant increase. From the individual stock structure, southbound buying is relatively concentrated, with significant inflows into Alibaba, China Mobile, SMIC, Kuaishou, etc., while outflows occurred from Meituan, Tencent Holdings, etc. Notably, Alibaba saw a significant inflow of HKD 17.3 billion this week, accounting for one-third of the net inflow of southbound funds for the week, and the proportion of southbound holdings in Alibaba increased from 5.2% last Friday to 5.8%, a rise of 0.6 percentage points.

Chart: EPFR data shows that passive foreign capital continues to flow in significantly, but active funds are still flowing out Source: Bloomberg, FactSet, Wind, CICC Research Department Chart: Southbound funds account for about 30% of the trading volume on the Hong Kong Stock Exchange's main board Source: Bloomberg, Wind, CICC Research Department

Chart: The market value of southbound funds' holdings accounts for about 10% of the total market value of the Hong Kong main board Source: Bloomberg, FactSet, Wind, CICC Research Department

Chart: The holding ratio of the top ten most active stocks this week has increased Source: Bloomberg, Wind, CICC Research Department

II. How will the subsequent market develop? Short-term needs to grasp the rhythm, long-term focuses more on structure

From the analysis above, it is not difficult to see that the essence of this round of rebound is based on optimistic sentiment towards technological trends, driven by a very typical bottom-up structural market. The direction of the macro narrative is undoubtedly correct, but in the long term, it remains to be verified, and in the short term, it cannot be falsified. The extent to which future expectations are factored in directly determines the differences in space judgments among different investors. Cautious investors see more short-term overextension in valuation, sentiment, and technical aspects, as well as uncertainties in the realization of future expectations; optimistic investors see more opportunities for greater valuation reassessment, capital reallocation, corporate innovation capabilities, and willingness for capital expenditure, and even potential changes in the overall macro narrative (《Revaluation of Chinese Assets?》).

At this Alibaba earnings meeting, it was announced that capital expenditure on AI in the next three years will exceed that of the past ten years [1]. Its main significance in the short term lies in the continuity it brings to the previous macro narrative. The starting point of the market comes from the revaluation of the application prospects of China's AI industry triggered by the birth of the DeepSeek-R1 model during the Spring Festival, due to its low cost and open-source model. The technological equality brought by open-source will promote the development of domestic computing power and application ends, while Alibaba's capital expenditure plan gives the market more expectations for resource investment, continuing the recently fermenting optimistic sentiment As for the long-term outlook, it is not the focus of short-term market trading.

However, it should still be emphasized that after further strengthening performance and sentiment in the short term, there has also been an increase in divergence in rhythm, manifested by the short-selling transaction ratio dropping to a relatively low level. At the same time, several inverse Hong Kong stock ETFs (such as 7552.HK/7500.HK) saw significant inflows last week of HKD 900 million and HKD 300 million, respectively, reaching new highs since their inception and since July 2021.

Therefore, under the current circumstances where long-term logic remains to be verified and short-term optimistic sentiment cannot be falsified, we have consistently emphasized a few points: 1) From a technical and sentiment indicator perspective, the short-term may have already been overdrawn, as the 6-day RSI once rose close to 90, and the 14-day RSI exceeded 80 (above 70 indicates an overbought zone), approaching the early October high point. The risk premium of the Hang Seng Index has also dropped to its lowest level since June 2021; 2) Actively intervene at low levels, but at euphoric positions, it is advisable to lock in profits moderately and grasp the rhythm well. At the current point, understanding the structure and rhythm becomes increasingly important; 3) In the long term, the current bottom-up driven market is more conducive to forming a structural market, so focusing on structure is essential for outperforming.

In terms of short-term rhythm, we believe it depends on the following factors: 1) Catalysts within the industry itself, such as the continuation of sentiment from Alibaba's earnings meeting capital expenditures last week; 2) The degree of technical overdraw, during a vacuum period where fundamental progress is stalled, attention should still be paid to changes in sentiment for short-term indications of market rhythm; 3) The "momentum" of capital, from our constructed foreign capital profile, the dominant value-type funds are still flowing out, and sustained and significant inflows still require clearer directions from fundamentals and industry trends. Currently, the main buying force is still from southbound and passive, trading-type funds, which are easily disturbed by sentiment and fluctuate back and forth, with sustainability still needing observation (《How Much Allocation Space Do Foreign Funds Have?》); 4) Other macro-level changes, such as policy developments during the upcoming Two Sessions, and external disturbances, such as the Federal Reserve's interest rate cut rhythm and the progress of Trump's policies (such as the recently signed priority investment policy).

Chart: In the foreign capital profile, overseas active value-type funds dominate Source: Bloomberg, FactSet, Wind, CICC Research Department

Chart: Sustained and significant inflows still require clearer directions from fundamentals and industry trends Data source: EPFR, Wind, CICC Research Department

III. How much room is left? Three methods of calculation suggest observing around 23,000-24,000 points, or even taking moderate profits.

1. Under the overall method, current sentiment has surpassed the high point since last October (6%), with the risk premium falling to 5.8%. We previously calculated that if the risk premium returns to the 6% level corresponding to the high points in early October last year and early 2023, it would correspond to the Hang Seng Index around 23,000 points. Current sentiment has already returned to a level similar to June 2021.

2. Under the structural method, considering the characteristics of the current technology narrative and structural performance, the overall method may obscure the narrative of the technology sector itself, so separating and calculating is more comparable. The overall risk premium of the technology sector is currently 1.91%, lower than the 2.8% corresponding to the high point in early October last year, but still not reaching the 1.7% corresponding to early 2023; the risk premium of other sectors is 8.3%, still higher than the 7.6% corresponding to the high point in early October last year. If we assume that the sentiment in the technology sector further boosts its risk premium back to the level of early 2023, while the sentiment in other sectors remains unchanged, it would correspond to the Hang Seng Index at 24,000; if we take it a step further and let the sentiment in technology stocks return to the optimistic level of historical highs in 2021, while other sectors remain unchanged, it would correspond to the Hang Seng Index at 25,000 points.

Chart: Most constituent stocks of the Hang Seng Index show no significant increase Data source: Bloomberg, Wind, CICC Research Department

Chart: Optimistic sentiment in the technology sector rises to early 2023, corresponding to the Hang Seng Index around 24,000 points Data source: Bloomberg, FactSet, Wind, CICC Research Department

1. Bottom-up method: As mentioned earlier, the current structural market space is almost entirely determined by a few rising stocks. Considering the impact of key stocks on the overall index points, combined with CICC analysts' target point calculations for key stocks, if these stocks all reach their targets, assuming the market value of other stocks remains unchanged, the weighted corresponding Hang Seng Index would be around 25,000 points, which is comparable to the more extreme optimistic level we calculated above Overall, we believe that while the general direction is important, short-term rhythm also needs to be grasped. Therefore, we suggest observing catalysts or even taking moderate profits around the 23,000-24,000 point range before deciding on the next steps. It is worth noting that as the current rally progresses, the Hang Seng Index has broken through daily and weekly resistance levels, followed by monthly resistance levels, corresponding to around 23,800 points.

At the same time, we remind that on February 21, the quarterly adjustment results of the Hang Seng series indices will be announced. Since the Hang Seng Index and the Hang Seng TECH Index limit individual stock weights to a maximum of 8%, stocks that have recently seen significant price increases and thus exceed this weight (such as Alibaba, Tencent, HSBC, Xiaomi, SMIC, etc.) will lead to passive funds "reducing" their weights on the adjustment execution date (March 7). We estimate that the required outflow time for Alibaba, Tencent, and Xiaomi will not exceed 0.6, 0.1, and 0.1 days, respectively, which has limited direct impact but can be monitored for emotional resonance leading to selling "excuses" (Analysis of the Impact of Hang Seng and Stock Connect Adjustments).

IV. Long-term Outlook: Expected to Foster a More Distinct Structural Market

In the long run, the characteristics of a "structural market" will become increasingly prominent. Currently, there are two macro conditions that support a structural market: First, the overall economy is in a stable leverage adjustment phase, thus lacking an overall trend, similar to the supply-side excess seen in 2012-2014, where PPI remained negative; facing trade frictions in 2019 and financial deleveraging in 2018. At this time, the overall market may present a volatile pattern, especially for cyclical sectors that are more related to macroeconomic factors, making it difficult to expect significant upward movements like those during periods of increased leverage (such as the secondary market leverage from late 2014 to mid-2015, and the leverage increase by residents from 2016 to 2017, and by the government and residents in early 2020-2021); Second, there are established industrial trends to support which can drive sufficient funds into certain industries to form independent structural markets (such as the consumer electronics and media mobile game markets driven by smartphones and the transition from 3G to 4G during 2012-2014; the self-controllable semiconductor and new energy industries in 2019) (Is There a Revaluation of Chinese Assets?).

In this context, the advantages of Hong Kong stocks are: 1) In terms of industry distribution, the profitability and ROE of new economy sectors like the internet are generally better than traditional consumption and manufacturing, especially during this round of increases where Hong Kong stocks have significantly benefited from the rise of software stocks and internet leaders; 2) In terms of funding preferences, foreign capital favors internet giants and software applications with Chinese characteristics, which is also the reason for the noticeable inflow into Hong Kong stocks while foreign capital has not returned to A-shares in this round (Outlook for Hong Kong Stocks in 2025: Cloudy but No Rain).

So, theoretically, how much space is there for foreign capital? We estimate: 1) Scenario One: Since actively managed funds targeting global and Asian markets (excluding Japan) are overweight in South Korea and India, if subsequent active foreign capital allocations to these two markets drop to near five-year lows, funds could rebalance to China, corresponding to an inflow of $6.3 billion, close to the outflow scale from October 2024 to now ($8.8 billion); 2) Scenario Two: Currently, the low allocation of 1.1 percentage points is fully converted to standard allocation (as of the end of 2021), corresponding to an inflow of USD 40.3 billion, which is equivalent to the total outflow from the Chinese market since 2021 under the EPFR standard (approximately USD 41.9 billion).

However, it is important to note that the premise for the active return of foreign capital requires further realization of the AI industry trend and macro narrative to provide more catalysts.

In terms of allocation recommendations, we suggest focusing on four main lines: 1) Stable returns (dividends + buybacks, especially for growth companies with a high proportion of net cash); 2) Going overseas, primarily in mid-end manufacturing, media, and new retail; 3) Technology (DeepSeek related AI computing power and AI applications), such as cloud servers, domestic computing power manufacturers, AIDC, AI application software, intelligent driving, humanoid robots, and consumer electronics; 4) New consumption.

Future focus: January PCE in the U.S. on February 28, February PMI in China on March 1, and the two sessions in March.

Author of this article: Liu Gang S0080512030003, Wu Wei S0080524070001, etc., Source: CICC Insights, Original title: "CICC: Re-discussing the Revaluation Prospects of Chinese Assets"

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