CICC: Can Hong Kong stocks still be bought?

Last week, Hong Kong stocks rebounded strongly and reached a new high. The domestic government work report and Trump's speech in the U.S. Congress met expectations, alleviating previous market concerns about potentially disappointing results. Additionally, the launch of the general-purpose AI Agent product Manus provided new catalysts for the revaluation of technology stocks, leading to a rapid rebound after a week of correction. The Hang Seng Tech Index surged 8.4%, the Hang Seng Index rose 5.6%, and the Hang Seng China Enterprises Index and MSCI China Index increased by 5.9% and 6.4%, respectively. In terms of sectors, media and entertainment (+11.3%), materials (+8.0%), and consumer discretionary (+7.6%) led the gains, while healthcare declined (-0.1%), and transportation (+0.9%) and utilities (+0.9%) lagged behind.

Chart: In the past week, Hong Kong stocks in media and entertainment and materials led the gains, while healthcare fell against the trend.

Source: FactSet, Bloomberg, CICC Research Department

Since the Spring Festival holiday, the AI boom has significantly changed investor sentiment and the macro narrative, driving the continuous rise of the Hong Kong stock market. The Hang Seng Index and Hang Seng Tech Index have cumulatively increased by 19.8% and 27.8%, respectively, with valuation expansion contributing 18.0% and 24.1%, while earnings only contributed slightly at 1.6% and 3.0%. The market's upward trend mainly relies on valuation-driven factors, with optimistic expectations for the future accounting for the vast majority (reflected as risk premium ERP). So, at this point, to what extent has the valuation of Hong Kong stocks been repaired, and how much expansion space is there for the future?

Chart: The upward trend of the Hong Kong stock market mainly relies on valuation-driven factors.

Source: FactSet, Bloomberg, CICC Research Department

1. What position has the valuation of Hong Kong stocks been repaired to? From a static perspective, it is still at a historical mid-low level.

1) Vertical comparison: The dynamic PE of the Hang Seng Index has recovered from 9.1x before the Spring Festival holiday to around the historical average of 10.8x, corresponding to the 61.2% percentile since data has been available in 2013; the dynamic PE of the Hang Seng Tech Index has recovered from 15.6x before the Spring Festival holiday to 19.3x, still below the historical average, corresponding to the 33.2% percentile since data has been available in July 2020 Chart: Hang Seng Index dynamic PE repairs to historical average levels

Source: FactSet, Bloomberg, CICC Research Department

Chart: Hang Seng Tech dynamic PE still below historical average

Source: FactSet, Bloomberg, CICC Research Department

2) Horizontal comparison, the dynamic PE of the Hong Kong stock market remains low compared to major global markets, and the dividend yield of the Hang Seng Index (~3.2%) is still significantly higher than the 10-year Chinese government bond yield (~1.8%). Recently, the market rebound has caused the ratio of the two to fall back but still remains more than one standard deviation above the historical average.

Chart: Hong Kong stock market dynamic PE remains low compared to major global markets

Source: FactSet, Bloomberg, CICC Research Department

Chart: Hang Seng Index dividend yield (~3.2%) still significantly higher than the 10-year Chinese government bond yield (~1.8%)

Source: FactSet, Bloomberg, CICC Research Department 3) In terms of sectors, the differentiation between new and old economies is evident, with the dynamic PE of the new economy rising to 16.7x and the old economy rising to 6.1x, both below the average since 2015. In the sub-sectors, valuations in finance, materials, and other sectors have recovered to historical averages, while retail, media entertainment, and consumer services sectors remain at historically low valuations.

Chart: Valuations in retail, media entertainment, and consumer services sectors remain at historically low levels

Source: FactSet, Bloomberg, Wind, CICC Research Department

4) At the individual stock level, under comparable company criteria, the valuations of Hong Kong stocks are lower than those of major markets such as the US. The dynamic PE average of China's "Ten Tech Giants" is 21.9x, lower than the 28.4x of the US "Seven Sisters" in technology.

Therefore, from a static perspective, whether comparing horizontally with other assets and markets or vertically with historical trends, even within the sectors and individual stocks of the Hong Kong market, the current valuation of Hong Kong stocks remains at a relatively low level within historical ranges.

However, valuation analysis that ignores changes in the macro and market environment and only focuses on absolute values and percentile comparisons may be "carving a boat to seek a sword." After all, the premise of horizontal and vertical comparisons is the assumption of valuation "mean" reversion, but history may never return to the past. Therefore, a reasonable judgment on valuation requires finding valuation anchors, especially in conjunction with the current macro and market environment. We analyze the reasons and prospects for recent valuation expansion by establishing a basic framework to explain valuation changes.

II. What drove the rapid rebound in valuations? From a dynamic perspective, the sentiment-driven recovery is basically in place.

Valuation is the final trading result of the joint effects of fundamentals, policies, liquidity, and sentiment, which can be simply broken down into financing costs (rf) and risk premiums (Equity risk premium, ERP). The former typically uses the 10-year government bond yield as the risk-free rate (considering the uniqueness of the Hong Kong stock market, we use a weighted average of China bonds and US bonds at a 3:7 ratio as the risk-free rate), while the latter is the sum of other unexplained parts or residuals. For local markets, such as US stocks and China's A-shares, the risk premium is more composed of "local premiums" from macro premiums (policies and fundamentals) and micro premiums (liquidity and sentiment); for offshore markets like Hong Kong stocks, an additional "country premium" applicable to foreign investors is also needed.

Since the Spring Festival holiday, the Hang Seng Index and Hang Seng Tech valuations have expanded by 18.0% and 24.1%, respectively, with the risk-free rate contributing only a slight 1.6%. The remainder is entirely contributed by the decline in risk premium ERP, which is also a direct reflection of optimistic narratives and expectations. ** Currently, the Hang Seng Index risk premium has fallen to 5.7%, close to the market peak of 5.4% in early 2021. The Hang Seng Tech risk premium has dropped to 1.6%, below the historical average since data became available in July 2020, and the gap from the historical high of 0.3% in early 2021 has narrowed. The Hang Seng Tech index has only 30 constituent stocks, making the impact of index rebalancing significant, and the historical comparability of the risk premium is limited.

Chart: The Hang Seng Index risk premium has fallen to 5.7%, close to the market peak of 5.4% in early 2021.

Source: FactSet, Bloomberg, EPFR, CICC Research Department

Chart: The Hang Seng Tech risk premium has also fallen to 1.6%, near the historical average since data became available in July 2020.

Source: FactSet, Bloomberg, Wind, CICC Research Department

The rapid decline in risk premium is due to two reasons: 1) A narrative shift boosts risk appetite. DeepSeek has sparked enthusiasm in the market for the reassessment of tech stocks and even overall Chinese assets, with new catalysts continuously emerging, including the launch of the general-purpose AI Agent product Manus, leading to improving investor sentiment; 2) Accelerated inflow of southbound funds increases pricing power over Hong Kong stocks. As an offshore market, Hong Kong stocks reflect the viewpoints of both domestic and foreign investors. FactSet's bottom-up aggregation shows that foreign capital accounts for over 65% of the MSCI China top 100 weighted stocks that can be disaggregated. Foreign investors typically demand higher risk compensation based on "country premium," which has long suppressed the valuation of Hong Kong stocks. Recently, there has been a significant inflow of southbound funds, with a cumulative purchase of HKD 313.9 billion since the beginning of the year, more than five times that of the same period last year, and the southbound trading proportion remains around 30%. Historically, when the southbound trading proportion rises, it corresponds to a phase of decline in AH premium, and the activity level of mainland investors in the Hong Kong stock market affects the revaluation of Hong Kong asset prices Chart: Southbound funds accelerate inflow, increasing pricing influence on Hong Kong stocks

Source: FactSet, Bloomberg, EPFR, China International Capital Corporation Research Department

Chart: Southbound trading volume proportion rises, corresponding to a temporary decline in AH premium

Source: FactSet, Bloomberg, Wind, China International Capital Corporation Research Department

III. How much room is there for valuation expansion? The dividend sector has a relative space of 5% compared to A-shares, while the technology sector's ROE has basically matched

Based on the above valuation analysis framework, short-term changes in the risk-free rate are relatively limited, and more attention should be paid to changes in risk premium. The short-term risk premium depends on the characteristics of funds, such as the continuous increase in southbound trading volume, while the long-term risk premium depends on profit prospects. If profits can be realized, there may even be a situation where the higher the price, the lower the valuation.

In specific analysis, this round of rebound shows obvious structural characteristics. Although the recent market has spread, the increase and trading activity of technology stocks still exceed other sectors, so we use a dichotomous method to judge the valuation expansion space.

► Traditional sectors: From a dividend perspective, there is still considerable room relative to government bond rates, but the relative space to A-shares is 5%. The recovery height of traditional sectors relies heavily on macroeconomic policies and the overall economic leverage recovery, which is different from the "924 market." Therefore, traditional sectors still mainly focus on dividend investment. In this round of technology-led rebound, the support of sentiment and fund inflows has also caused traditional sectors to rise, although they cannot outperform, further narrowing the AH premium from 141% to 131%, which is below the historical average by one standard deviation. Hong Kong stocks still have a 31% discount compared to A-shares. Among the 151 companies listed in both markets, the vast majority are state-owned enterprises and traditional sectors, with financial, energy, telecommunications, and public utilities accounting for about 80% of the market capitalization. The higher discount of Hong Kong stocks means that the dividend yield is significantly higher than that of A-shares. Even considering dividend taxes (20% for individual investors in H-shares, up to 28% for red-chip stocks; corporate investors are exempt from tax if held for 12 months), it remains attractive. This partly explains why mainland southbound funds continue to favor high-dividend targets in Hong Kong, with the shareholding ratio of China Telecom and China Shenhua by southbound funds exceeding 50% In this sense, when the after-tax dividend yield of the same company in the A-shares and Hong Kong stocks is equal, that is, when the AH premium converges to 125%, the attractiveness of dividends to southbound investors will be greatly reduced, corresponding to a space of 5% for the dividend sector relative to A-shares.

Chart: A/H premium converges to 131.4, below the historical mean by 1 standard deviation

Source: FactSet, Bloomberg, Wind, CICC Research Department

► Technology Sector: Current valuations and ROE have basically matched, and more space relies on profit improvement. DeepSeek has sparked market enthusiasm for the revaluation of technology stocks, but after a month of continuous rise, are technology stocks still undervalued? In absolute terms, it seems so, but considering current profitability, further expansion requires more realization; otherwise, there is a lack of space. Domestic technology stocks have not previously participated in the global ChatGPT market, resulting in a widening gap in stock price and valuation performance between China's technology leaders (Terrific 10, all Hong Kong stocks) and the U.S. technology leaders (Magnificent 7) over the past two years. The dynamic PE and PEG of China's technology leaders are only 17.7x and 1.41x, significantly lower than the U.S. technology leaders' 27.9x and 2.58x.

Chart: The gap in stock prices between China's technology leaders and U.S. technology leaders has widened over the past two years

Source: FactSet, Bloomberg, Wind, CICC Research Department

Chart: The dynamic PE of China's technology leaders is significantly lower than that of the U.S.

Data Source: FactSet, Bloomberg, Wind, CICC Research Department

Chart: The dynamic PEG of Chinese technology leaders is also lower than that of American technology leaders

Data Source: FactSet, Bloomberg, Wind, CICC Research Department

However, the high valuation of American technology leaders is supported by profitability, which is currently a weak point for Chinese technology stocks. Based on this ratio, the valuation is already reasonable: 1) The market capitalization of Chinese technology leaders accounts for 28.9% of all Hong Kong stocks, higher than America's 26.6%, but the net profit share of Chinese technology leaders is only 13.3%, lower than America's 15.7%.

Chart: The market capitalization of Chinese technology leaders accounts for 28.9% of the Hong Kong stock market, already higher than America's 26.6%

Data Source: FactSet, Bloomberg, Wind, CICC Research Department

Chart: The net profit share of Chinese technology leaders is only 13.3%, lower than America's 15.7%

Data Source: FactSet, Bloomberg, Wind, CICC Research Department

1. The ROE and profit margins of American technology leaders are generally higher than those of Chinese technology leaders. If we assume that the overall dynamic PE of American technology stocks (28.1x) matches the expected ROE (34.2%), then the overall dynamic PE of Chinese technology stocks (17.4x) is even relatively overvalued compared to the expected ROE (16.8%). A reasonable valuation may be in the range of 15-16 times.
2. At the individual stock level, the dynamic P/E average of Chinese tech stocks under comparable company standards is 21.9x, lower than the 34.5x of U.S. tech stocks, but the average profit margin is only 13.2%, also lower than the 28.4% of U.S. tech stocks.

Therefore, the estimation of valuation expansion space for the tech sector relies more on the improvement of profitability. 1) If we refer to the target valuations set by CICC analysts for individual stocks, leading Chinese tech stocks may have a 15% expansion space in valuation, although there are differences among individual stocks. 2) If the expected ROE of leading Chinese tech companies can reach above 30%, then a doubling of valuation can be achieved by referencing the valuations of leading U.S. tech companies. However, before profit expectations are significantly revised upward, the valuation expansion of tech stocks still depends on emotional boosts brought by event catalysts, which is also the reason why the market had previously paused and adjusted. In a situation where static sentiment and technical aspects are overdrawn, the long-term macro narrative remains to be validated but cannot be falsified in the short term, and market upward movement requires continuous catalysts.

Operational suggestion: The essence of this round of rebound is based on optimistic sentiment towards tech trends. The extent to which this sentiment is accounted for and how much "imagination" space remains for the future are key to answering the future market space. We believe that 1) the current AI trend, narrative changes, and the general direction of valuation reassessment are correct, but 2) in the short term, it is also necessary to grasp the rhythm, with position and cost being equally important. If the expectation for short-term new catalysts is limited, or if there is a risk of policies falling short of expectations and increased external disturbances, it is better to adopt a short-term wait-and-see approach. We continue to maintain the short-term Hang Seng Index target of 23,000-24,000, with an optimistic scenario of 25,000 as outlined in our recent series of reports on "Reassessing the Prospects of Chinese Assets." It should be noted that such a static calculation does not mean that once reached, there will definitely be a sharp decline, nor does it mean that it won't break through under the boost of short-term funds and sentiment ("Reassessing Chinese Assets?"), but it does mean that before long-term expectations can be fulfilled, the continuous overdraw of optimistic sentiment also implies a potential increase in market divergence.

Since the end of 2023, Hong Kong stocks have experienced four rounds of rapid rebounds followed by overdrawn corrections, but the phenomenon of continuously rising bottoms (trillions of government bonds at the end of 2023, real estate policies for May Day 2024, the 924 market in 2024, and the market after the Spring Festival in early 2025) indicates that: 1) The effectiveness of policy efforts is evident, hence the continuously rising bottoms, and even if the market corrects, it will not completely erase previous declines; 2) However, the market will linearly extrapolate its intensity, leading to overdrawn corrections after rapid surges. Therefore, the best strategy to cope with this situation is to "actively buy when prices are low and take moderate profits when exuberant," while focusing more on structural trends with fundamental and industrial backing.

In terms of industry, the mid-term will still focus on structural trends, primarily driven by technology with industrial trends. However, in the short term, if adjusting positions, one can choose to balance some towards previously underperforming dividend assets. Looking long-term, we still recommend focusing on four main lines for current allocations: 1) Stable returns (dividends + buybacks, especially for growth companies with a high proportion of net cash); 2) 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; 3) Going overseas, focusing on mid-range manufacturing, media, and new retail; 4) New consumption, meeting the new consumption leaders that satisfy current population and consumption habits.

Future Focus: March China financial data, March 12 U.S. CPI, March 17 China economic data.

Article authors: Liu Gang, Wang Muyao, etc., source: CICC Insight, original title: "CICC: Can Hong Kong stocks still be bought?"

Risk Warning and Disclaimer

The market has risks, and investment requires caution. This article does not constitute personal investment advice and does not take into account the specific investment objectives, financial conditions, or needs of individual users. Users should consider whether any opinions, views, or conclusions in this article are suitable for their specific circumstances. Investment based on this is at one's own risk