Xingzheng Strategy: Eight Important Questions in the Hong Kong Stock Market Recently

According to the Zhitong Finance APP, Xingzheng Securities published a research report stating that southbound funds have become one of the main forces driving the bullish trend in Hong Kong stocks, in stark contrast to the pace of foreign capital inflows, and are more resolute in their inflow rhythm. From the perspective of fund flow sectors, growth sectors such as AI and pharmaceuticals are favored, while southbound funds continue to flow into dividend sectors. In addition, although the current valuation of Hong Kong stocks has risen, it remains within an exploitable range overall, and compared to U.S. stocks, most Hong Kong stock industries exhibit significant discounts, with some industries having advantages in valuation and profitability. The leading technology stocks in Hong Kong are also significantly discounted compared to U.S. technology stocks, with many Hong Kong companies standing out in terms of cost-effectiveness relative to their U.S. counterparts.

1. Who is buying Hong Kong stocks?

According to the breakdown from the Hong Kong stock custody institutions, southbound funds are one of the main capital forces driving the bullish trend in Hong Kong stocks this time. From January 14 to February 26, the cumulative net inflow of the Hong Kong Stock Connect reached HKD 167.21 billion, while during the same period, international intermediaries, Chinese intermediaries, and local Hong Kong intermediaries reduced their positions by HKD 78.70 billion, HKD 55.46 billion, and HKD 9.77 billion, respectively.

In terms of rhythm, the net inflow of foreign capital increased before and after the Spring Festival, but it took profits in mid-February, while mainland funds continued to flow southward. Specifically, DeepSeek triggered a reassessment of Chinese assets by overseas funds, with international intermediaries representing foreign capital starting to rapidly increase their positions in Hong Kong stocks from January 27, but began to net outflows on February 17. In contrast, southbound funds continuously contributed incremental capital to Hong Kong stocks.

Moreover, compared to previous rebounds in Hong Kong stocks, the inflow of southbound funds this time is more resolute. Compared to the four macro-driven rebounds during 2022-2024, this round of improvement is more derived from industrial trend iterations and corporate profit recovery, coupled with the fact that the positions and valuations of Hong Kong stocks remain relatively low after a significant rise. Therefore, the net inflow pace of southbound funds has gradually accelerated, especially showing a "buy more as it falls" characteristic in the recent week of market fluctuations and adjustments.

2. Which sectors are various funds mainly flowing into?

From an industry perspective, in the hot market of Hong Kong stocks since the Spring Festival, growth sectors such as AI and pharmaceuticals are the main directions for fund inflows, while dividend-related sectors have seen significant reductions. According to estimates, from February 3 to February 26, funds mainly increased their positions in software services, specialty retail (mainly Alibaba), pharmaceuticals and biotechnology, media and entertainment, and telecommunications, while there was significant net outflow from industries such as banking, insurance, construction, textiles and apparel, and industrial engineering.

Although the AI sector is a consensus among southbound funds and foreign capital, there are differences in specific allocation segments. Foreign capital has significantly increased its allocation in upstream segments represented by software services and information technology equipment, while southbound funds, in addition to increasing allocations in specialty retail, telecommunications, and semiconductors, have also widely increased allocations in many "AI+" fields, including media entertainment, healthcare, and automotive Moreover, it is worth noting that, aside from the "AI+" sector, southbound funds continue to flow into the dividend sector, resonating with some Chinese intermediaries and local Hong Kong intermediaries. From February 3 to February 26, southbound funds continued to flow into the dividend sector represented by banks, utilities, and insurance, and resonated with Chinese intermediary funds in the utilities and insurance sectors.

On the individual stock level, looking at the top ten stocks with net inflows from four types of institutions:

Southbound funds follow a "technology + dividend" "dumbbell" configuration. They not only significantly flow into AI companies represented by Alibaba, China Mobile, Kuaishou, SMIC, and Black Sesame Intelligence, but also continue to flow into high-dividend stocks represented by Industrial and Commercial Bank of China and Bank of China. However, the Hong Kong Stock Connect has reduced holdings in Tencent Holdings, China National Offshore Oil Corporation, and Xiaomi Group.

Foreign capital significantly favors technology and consumer companies with distinctive business models, reducing holdings in Alibaba and the financial sector. On one hand, they have significantly increased holdings in technology leaders such as Tencent, Xiaomi, Meituan, SenseTime, Kingdee International, BYD Electronics, and Black Sesame Intelligence; on the other hand, there is also some preference for certain "new consumption" companies, including Laoputang Gold and Miniso. Additionally, the reduction in foreign capital is mainly concentrated in Alibaba and financial stocks such as AIA Group, HSBC Holdings, and China Merchants Bank.

Chinese intermediary funds continue to flow into high-dividend stocks in finance and oil, mainly reducing holdings in the recently popular Tencent Holdings and Alibaba. The top three stocks with net inflows from Chinese intermediaries are Postal Savings Bank of China, Ping An Insurance, and China National Offshore Oil Corporation, with significant reductions in Tencent Holdings, Alibaba, and HSBC Holdings.

Local Hong Kong intermediaries have a more diversified and "niche" allocation, but similarly mainly reduce holdings in Tencent Holdings and Alibaba. Local Hong Kong intermediaries mainly increased holdings in Central New Energy, China Ruyi, Fosun International, and Lingbao Gold, with significant net outflows from Alibaba and Tencent Holdings.

3. What is the position of various funds in Hong Kong stocks? 

(1) Foreign Capital The scale of foreign capital holding Hong Kong stocks is at a medium level since 2021, while the proportion of foreign capital holdings in Hong Kong stocks is at a historical low. As of February 26, the market value of shares held by international intermediaries was HKD 16.3 trillion, accounting for 45.65% of the circulating market value of Hong Kong stocks, which is at a low percentile level of 11.1% since 2021. Compared to the market value of holdings in February 2021 and January 2023, there may still be an increase space of HKD 1.87/7.70 trillion for foreign capital holdings. Based on the proportion of market value holdings during the peak periods of 2023 and 2021, assuming the market value of Hong Kong stocks remains unchanged, foreign capital may still have an increase space of HKD 1.41/0.24 trillion in holding scale.

(2) Mainland Public Funds

As of Q4 2024, the public fund position in Hong Kong stocks is 11.5%, with some room for improvement compared to historical highs. As of Q4 2024, under the full holding caliber, the market value of active equity funds' investments in Hong Kong stocks was HKD 367.558 billion, accounting for 11.5% of the total stock investment market value. Assuming their position in Hong Kong stocks returns to historical highs, it is estimated that there could still be an incremental scale of over HKD 70 billion based on the holding scale in Q4 2024.

(3) Non-Public Fund Stock Connect

Thanks to the significant inflow of southbound funds in recent years, in the fourth quarter of last year, the market value of Stock Connect holdings, excluding public funds, exceeded HKD 3.4 trillion. As of Q4 2024, after excluding the market value of Hong Kong stock investments from non-QDII public funds, the remaining market value of mainland funds through Stock Connect was HKD 3,012.48 billion, accounting for 87.9%. Assuming that the position of insurance funds in Hong Kong stocks is between 10%-30%, based on the estimated market value of stock and fund investments in the insurance fund utilization balance, the proportion of insurance holdings in Stock Connect is about 13%-40%, which means that more than half of the funds in Stock Connect may come from retail investors, private equity, and bank wealth management, among other investors.

IV. What is the structure of various funds' holdings in Hong Kong stocks?

(1) Foreign Capital Foreign capital prefers the information technology, consumer discretionary, and financial sectors, with a combined position accounting for nearly 80%. As of February 26, the top five heavily weighted sectors by international intermediaries are consumer discretionary, information technology, finance, real estate and construction, and industrials. Moreover, looking at the long term, despite significant outflows of foreign capital from Hong Kong stocks in recent years, the combined position in information technology and consumer discretionary has continued to rise, remaining comparable to the levels in February 2021 and January 2023.

(2) Mainland Public Funds

Active equity funds have long been heavily invested in consumer discretionary and information technology. As of the fourth quarter of last year, the top five holdings of public funds in Hong Kong stocks, based on the top ten holdings, were information technology, consumer discretionary, healthcare, energy, and industrials. However, due to the increased allocation to dividend sectors in recent years, the current position of active equity funds in the technology and internet sectors (information technology sector + Alibaba + Meituan, same throughout) has just returned to the level of the first quarter of 2023, still having a potential increase of 2.86% compared to the peak in Q1 2021.

(3) Non-Public Hong Kong Stock Connect

Non-public Hong Kong Stock Connect primarily focuses on finance, information technology, and consumer discretionary. As of Q4 2024, excluding public funds, the top five heavily weighted sectors in Hong Kong Stock Connect funds were finance, information technology, consumer discretionary, telecommunications, and energy. Compared to public funds, the allocation ratio of other mainland funds to dividend sectors is more significant. The combined holding ratio of information technology + Alibaba + Meituan in non-public Hong Kong Stock Connect is 27.19%, lower than the levels in Q1 2021 and Q1 2023, indicating potential room for adjustment in the future.

V. Which stocks are heavily held by various funds?

(1) Foreign Capital Since 2021, the top ten holdings of foreign capital have been exclusively dominated by technology and financial leaders. As of February 26, the top five heavily weighted stocks by international intermediaries are Tencent Holdings, Alibaba, Xiaomi Group, Meituan, and AIA Group. Since 2021, foreign capital's preference for individual stocks has remained relatively stable, with the top ten holdings being consistent, especially Tencent Holdings and Alibaba, which have long occupied the top two positions. Currently, most heavily held stocks have positions higher than the levels in February 2021 and January 2023. However, it is noteworthy that since April 2024, the proportion of holdings in the top five/top ten stocks by international intermediaries has surged, indicating a continued increase in the concentration of foreign capital holdings, primarily embracing Hong Kong's technology and financial leaders.

(2) Mainland Public Funds

The holdings of public funds in Hong Kong stocks fluctuate relatively significantly, but the preference for Tencent and Meituan remains stable. As of Q4 2024, the top five heavily weighted stocks in active equity funds are Tencent Holdings, Meituan, China National Offshore Oil Corporation, Xiaomi Group, and Alibaba. Compared to the heavily held stocks of foreign capital, the industry allocation of public funds in Hong Kong stocks is more diversified and subject to greater changes. Additionally, comparing Q1 2021 and Q1 2023, public funds still have considerable room for increasing positions in technology leaders such as Tencent Holdings, Meituan, Xiaomi, and Alibaba (3) Non-public offering Hong Kong Stock Connect

The non-public offering Hong Kong Stock Connect prefers high-dividend targets such as finance, energy, and operators. As of Q4 2024, the top five heavyweights in the Hong Kong Stock Connect funds, excluding public offerings, are Tencent Holdings, China Mobile, China National Offshore Oil Corporation, China Construction Bank, and Industrial and Commercial Bank of China.

6. After the rise, what is the current valuation level of Hong Kong stocks?

From the absolute valuation of the Hang Seng Index, as of February 26, the PE_TTM of the Hang Seng Index is 10.36, which is at the 65.1% percentile level over the past five years, slightly lower than the peak price level on January 27, 2023, and has a 40.8% discount compared to the peak on February 17, 2021.

From the absolute valuation of the Hang Seng TECH Index, as of February 26, the PE_TTM of the Hang Seng TECH Index is 24.69, which is at a relatively low percentile level of 29.6% over the past five years, with more than 130% room for improvement compared to January 2023, and a 50.3% discount compared to February 17, 2021. From the ERP of the Hang Seng Index, as of February 26, the ERP of the Hang Seng Index (based on the 10-year U.S. Treasury yield, same throughout) is 5.4%, at the 6.7% percentile level over the past five years, having broken below the mean -1 standard deviation level, comparable to the level in January 2023, with a 1% decline space compared to February 17, 2021 (assuming the 10-year U.S. Treasury yield remains unchanged, the implied valuation improvement space is 11.3%).

From the ERP of the Hang Seng TECH Index, as of February 26, the ERP of the Hang Seng TECH Index is -0.2%, at the 30.4% percentile level over the past five years, not yet breaking below the mean -1 standard deviation, but already lower than the level in February 2021, with a 1.6% decline space compared to January 27, 2023 (assuming the 10-year U.S. Treasury yield remains unchanged, the implied valuation improvement space is 65.7%). From the relative valuation of the Hang Seng Index compared to the S&P 500, as of February 26, the relative PE of the Hang Seng Index to the S&P 500 is 0.38, at a relatively low percentile level of 38.5% over the past five years. Based on the current U.S. stock valuation, the Hang Seng Index has a 35.7% improvement space compared to January 27, 2023, and a 13.3% improvement space compared to February 2021. From the relative valuation of the Hang Seng TECH Index compared to the Nasdaq 100, as of February 26, the relative PE of the Hang Seng TECH Index to the Nasdaq 100 is 0.70, at a relatively low percentile level of 32.9% over the past five years. Based on the current U.S. stock valuation, the Hang Seng TECH Index has a 199.4% improvement space compared to January 2023, and a 69.7% improvement space compared to February 2021.

7. How is the relative valuation of Hong Kong stocks compared to U.S. stocks in segmented industries?

 Comparing the 25-year expected PE and PB of Hong Kong stocks and US stocks, we find that most Hong Kong stock industries are significantly undervalued. Specifically, the Hong Kong stock sectors of retail (including Alibaba), materials, finance, and energy are undervalued by over 50% compared to US stocks, while some Hong Kong stock industries such as electronic technology, medical services, and medical technology have valuations higher than their US counterparts. Further from the PE-G framework, most Hong Kong stock industries represented by the internet are undervalued relative to US stocks, with superior 25-year EPS growth rates. Among them, the core technology service industry in Hong Kong stocks (including Tencent, NetEase, Baidu, Alibaba Health, Kingsoft Cloud, etc.), which is the main line of the current AI market, has seen its EPS advantage over US peers (including Microsoft, Oracle, IBM, Palantir, ServiceNow, etc.) continue to improve, but the valuation discount has been expanding. In addition, industries such as materials, energy, logistics services, finance, utilities, and transportation commercial services also have valuation and profitability advantages compared to their US counterparts.

8. From the perspective of leading companies, how do Hong Kong stocks compare to US stocks in terms of valuation?  

 Overall, leading technology stocks in Hong Kong are significantly undervalued compared to US technology stocks. As of February 26, the relative PE of the seven leading Hong Kong technology stocks compared to the "seven sisters" of US technology stocks (individual stock list can be found in the notes of Chart 10) is 0.71, which is at the medium percentile level of 44.2% over the past five years.

Based on current US stock valuations, the seven leading Hong Kong technology stocks have an upside potential of 117.9% compared to January 2023 and 55.8% compared to February 2021. Specifically, based on a bottom-up analysis of leading Hong Kong companies with distinctive businesses across various industries, most of them are relatively undervalued compared to US stocks in terms of the expected PB and PE for 25 years. Among them, Li Auto, BYD, JD.com, Industrial and Commercial Bank of China, China National Petroleum, Alibaba, Baidu, and Anta still have relatively high cost-performance ratios compared to US stocks