CICC: Is it a good time to "buy the dip" in Hong Kong stocks?
CICC analysis believes that the recent sharp decline in Hong Kong stocks was triggered by the U.S. tariff policy, with the Hang Seng Index recording its largest single-day drop of the 21st century, and an overall decline of 8.5% last week. Although there is a rebound in the short term, overall market sentiment remains under pressure. It is recommended that investors consider locking in some profits or reallocating some positions to cope with market uncertainty
With U.S. President Trump announcing unexpectedly high reciprocal tariffs, China quickly retaliated ("Unexpectedly High 'Reciprocal Tariffs'"), leading global markets to enter a risk-averse mode, with the Chinese market also affected. On the first trading day after the Qingming Festival holiday, although the market had somewhat anticipated this, the sharp decline in Hong Kong stocks still left most investors "astonished," setting multiple records. Among them, the Hang Seng Index fell 13.2% in a single day, marking the largest single-day drop since the 21st century. The Hang Seng Tech Index plummeted 17.2%, the largest drop since the index was established at the end of 2014.
In the following days, thanks to positive signals from the Central Huijin Investment, record buying from southbound funds, and a gradual "desensitization" of investor sentiment regarding tariff "escalation," the Hong Kong stock market rebounded over the next four trading days. However, overall, the Hang Seng Index still recorded a decline of 8.5% last week, the largest weekly drop since 2018. MSCI China, Hang Seng Tech, and Hang Seng China Enterprises also fell by 8.1%, 7.8%, and 7.4%, respectively. In terms of sectors, consumer discretionary (-10.7%), media and entertainment (-10.4%), and insurance (-10.1%) were under the most pressure. In contrast, consumer staples (+0.4%) saw a slight increase against the trend, while real estate (-1.2%) and telecommunications services (-2.5%) were relatively resilient.
Chart: MSCI China Index fell 8.1% in the past week, with consumer discretionary, media and entertainment, and insurance leading the decline.
Source: FactSet, CICC Research Department
In fact, we have been continuously suggesting since late February that the reasonable central level for the Hang Seng Index is 23,000-24,000 points, with an optimistic scenario of 25,000 points. Since the end of February, although the market has repeatedly surged due to short-term sentiment and capital inflows, it has never been able to "effectively break through" this level ("Revaluation of Chinese Assets?", "Revisiting the Prospects of Revaluation of Chinese Assets"). Although the market seems to be continuously lively, if investors had chosen to increase their positions in leading stocks or index products since the end of February, they would likely have been flat or even at a loss over the following month. Before the escalation of tariff risks, as sentiment continued to factor in, we suggested locking in some profits or shifting part of the positions to dividend-paying assets, as chasing high prices is not cost-effective ("Can Hong Kong Stocks Still Be Bought?"). If this had been done, at least some "unexpected" volatility could have been avoided, and some "bullets" could have been saved.
At the beginning of last week, we estimated in "How Big Will the Impact of 'Reciprocal Tariffs' Be?" that the Hang Seng Index was around 20,500 points, with expectations comparable to the level during the last round of Sino-U.S. trade friction at the end of 2018, and the market seems to have stabilized at this position. **With the extreme release of emotions after the "reciprocal tariffs" temporarily coming to an end, the tariff game seems to have entered the "second phase." The Hang Seng Index has corrected more than 15% from its late March peak, and the most concerning question in the market is,is now a good time to "buy the dip"?
Short-term emotional release is in place, more extreme than the 2018 trade friction, and absolute valuation has shown certain attractiveness
Regardless of the rise or fall, the market's initial reaction is driven by emotions (equity risk premium ERP). Since mid-January, the market momentum driven by DeepSeek has surged, primarily contributed by the decline in risk premium ERP. The previous risk premium of the Hang Seng Index reached a low of 6.0%, which is close to the emotions corresponding to last year's "924" and the early 2023 peak, corresponding to the current Hang Seng Index of 23,000-24,000 points. This is also the reason we suggested that profits could be taken moderately before earnings are realized and more catalysts arrive. Conversely, during the last round of escalating Sino-U.S. trade friction, the risk premium of the Hang Seng Index reached a high of 7.7% at the end of 2018 (reflecting not only trade friction but also financial deleveraging and the impact of the significant decline in U.S. stocks in the fourth quarter), if we refer to this sentiment, the corresponding point for the Hang Seng Index would be 20,500. Last Monday's sharp market drop raised the risk premium of the Hang Seng Index from 6.6% to 8.2%, and the market briefly fell to around 19,000, but subsequent recovery brought the market back above 20,500 points, indicating that this framework and calculation remain effective.
In the short term, the Hang Seng Index at 20,500 points has already accounted for emotions similar to those at the end of 2018, and it is also the central point around which the market may fluctuate in the short term. Although some investors may have doubts about using the end of 2018's emotions as a reference, in addition to the sudden trade friction in 2018, there was also financial deleveraging that began at the beginning of the year, along with the nearly 25% decline in U.S. stocks from October to December 2018, making it somewhat appropriate in a certain sense.
In terms of absolute valuation, 1) for the 40% "technology-inclusive" portion, after this week's market decline, the dynamic P/E of the Hang Seng Tech Index has quickly fallen from the mid-March peak of 19.1x to 14.0x, dropping below the average of the past three years. In our report "The Next Step for Hong Kong Stocks," we detailed the valuation situation of U.S. tech stocks and other emerging markets, judging that the overall valuation of Chinese tech stocks and Chinese-funded stocks is relatively reasonable, and after this round of significant decline, tech stock valuations have shown certain attractiveness; 2) for the remaining 60% "non-technology" portion, the relative advantage compared to A-shares has recently expanded to nearly 10%. From a dividend perspective, considering that individual and public fund investors in the Hong Kong Stock Connect need to pay at least 20% dividend tax, the AH premium has converged to 125% (100%/0.8), meaning that there is no difference for these investors when buying dividend assets in A-shares versus Hong Kong stocks. Therefore, during the recent market decline, the AH premium quickly rose from a previous low of 128% to 142%, providing certain space again Chart: Comparing the valuations of leading technology companies in China and the U.S. from a profitability perspective, the current valuation of Chinese technology leaders is also relatively reasonable.
Source: FactSet, CICC Research Department
Chart: During the recent market decline, the AH premium quickly rose from a previous low of 128% to 142%.
Source: Wind, CICC Research Department
The next step is to look at profit prospects, with domestic policy hedging being key, and tariffs gradually becoming "desensitized"
As short-term emotions have quickly been vented, coupled with the continuous escalation of tariffs entering a "non-rational" stage (considering the impact of price elasticity, after breaking a certain threshold, further increasing tariff levels has no practical economic significance), China has also stated that it "will not pay attention to this." Therefore, the market may gradually become "desensitized" to the actual numbers of tariffs in the short term, shifting focus to the substantive impact on growth, such as how much pressure there will be on profit downgrades?
Chart: The recovery of domestic prices is relatively slow, reflecting the increasing necessity for domestic policy efforts.
Source: Wind, CICC Research Department
In this regard, before seeing concrete progress in tariff negotiations, the impact of external demand on growth and profits remains unavoidable, so the strength and speed of domestic demand policy hedging will be crucial. The current U.S. tariffs on China are at 145% (two rounds of 10% fentanyl tariffs, 34% "reciprocal tariffs," followed by two rounds increased by 50% and 41% respectively), and if we include the first round of tariffs around 20% from 2018, the total level has reached as high as 165%. We are inquiring, "How significant will the impact of 'reciprocal tariffs' be?" According to the assessment, if tariffs increase by 54%, considering the impacts of price elasticity, the proportion of exports to the U.S., and the contribution of exports to growth, the profit growth rate of the Hong Kong stock market in 2025 may drop to negative growth from the current expected 4-5%. When tariffs exceed 100%, price elasticity may sharply increase, causing a non-linear shrinkage in export volume, coupled with profit margin pressure, which could raise the downward adjustment of profit growth rate to 10-15 percentage points.
Chart: Impact of different tariff assumptions on Hong Kong stock profit expectations
Source: FactSet, China International Capital Corporation Research Department
However, whether this impact and adjustment materialize depends not only on the unpredictable progress of tariff negotiations but also on the strength of domestic demand policy countermeasures. In other words, if domestic demand policies are timely and effective, this extent will not occur, nor will it put additional pressure on the market. The subsequent monthly changes in the broad fiscal impulse and the tone set by this month's Politburo meeting are worth close attention.
Chart: Suggested investors pay attention to the year-on-year changes in the scale of broad fiscal deficits to observe fiscal efforts
Source: Wind, China International Capital Corporation Research Department
In the short term, southbound funds remain the main force, while external disturbances may delay long-term foreign capital inflow
Since March, southbound funds have become the main force, setting a new record for inflows this week. Over the past month, southbound funds have maintained strong inflows. After a record inflow in mid-March, this Wednesday saw a single-day net inflow exceeding HKD 35 billion, setting another record, reflecting the enthusiasm of southbound investors for "bottom-fishing" in Hong Kong stocks. Since the beginning of this year, a cumulative inflow of HKD 581.3 billion has been recorded, with an average daily inflow (HKD 8.94 billion) already 2.5 times that of last year (with an inflow of HKD 807.9 billion in 2024, averaging HKD 3.47 billion daily). If the current pace is maintained, the total amount this year could approach HKD 2 trillion. In our report "How Much Space is Left for Southbound Inflows?", we conducted a detailed assessment, indicating that the "bullets" of institutions such as public offerings and insurance may not be as abundant as expected, while the sentiment and trend-driven nature of individual and speculative funds are difficult to measure and have historically shown instances of "chasing highs and cutting losses." Overall, the relatively certain incremental southbound inflow for the remainder of the year is estimated to be over HKD 300 billion In addition, it is worth noting that although southbound funds have continuously increased in trading volume and holdings in recent years, leading to an enhancement in marginal pricing power, it is difficult to possess "absolute pricing power" in the face of short selling with borrowed shares and the unlimited supply of "flash placements" (which southbound funds cannot participate in).
Chart: Southbound funds recorded a new single-day net inflow scale this Wednesday
Source: EPFR, Wind, CICC Research Department
Active foreign capital is accelerating outflow, and external disturbances may delay the return of long-term funds. Compared to southbound funds, although overseas funds have seen some return this year, the scale is significantly smaller than last year's "924," and is mainly composed of passive and trading funds. Active funds (mainly long-only) continue to flow out of the Chinese market, with a significant outflow of $690 million in the past week according to EPFR, nearly three times the previous week's outflow of $230 million. In the context of escalating tariff frictions, this may further delay the return of long-term foreign capital, especially from Europe and the United States. However, conversely, considering that the current global foreign capital allocation ratio to Chinese stocks is underweight by 1.2 percentage points, and the overall allocation ratio has decreased from the peak of 14.6% in October 2020 to the current 6.5%, which is also significantly lower than the level before the first round of trade frictions in 2018, the pressure for continued large-scale outflows is controllable, unless the U.S. implements more financial investment-related restrictions on China in the future.
Chart: EPFR shows that overseas active funds have recently accelerated their outflow from Chinese stocks
Source: EPFR, Wind, CICC Research Department
Chart: Current foreign capital is underweight by 1.16 percentage points in Chinese stocks, and the overall allocation ratio has decreased from the peak of 14.6% in October 2020 to the current 6.5%
 In the baseline scenario, market sentiment remains unchanged (7.7% risk premium at the peak of the last round of China-U.S. trade friction), without considering the impact of earnings downgrades, corresponding to the Hang Seng Index around 20,500 points;
2) In the optimistic scenario, market sentiment recovers to pre-tariff shock levels, earnings are not downgraded (policy hedging) but there is also temporarily no boost from the technology sector, the Hang Seng Index returns to 23,000-24,000 points. If further optimistic, assuming sentiment recovers to the early 2021 peak level (indicating significant progress on tariffs and a renewed strengthening of the technology narrative), earnings realize a 4-5% growth (policy hedging + technology earnings realization), corresponding to the Hang Seng Index around 25,000-26,000 points;
3) In the pessimistic scenario, market sentiment remains unchanged, and earnings growth drops to around -10% (tariff negotiations are not smooth, and domestic policy efforts are not timely), corresponding to the Hang Seng Index around 18,000 points.
Chart: In the baseline assumption, if the risk premium falls back to the previous round of trade friction escalation peak of 7.7%, the corresponding Hang Seng Index level is about 20,500 points
Data Source: Bloomberg, Wind, China International Capital Corporation Research Department In terms of specific operations, if investors have significantly reduced their positions or shifted to dividend sectors previously, they can gradually buy on dips at the current level; however, if their positions remain high, or if they are concerned about the pressure on profits from subsequent tariff and policy hedging developments, they may also leave more room for absorption later. In terms of sectors, 1) Internet technology, supported by technology narratives and with relatively low exposure to exports, remains the main line and can rotate with dividend assets. 2) The remaining broad consumption and pro-cyclical sectors rely more on macro policies and overall leverage repair; if fiscal measures can provide a hedge, pro-cyclical sectors related to domestic demand will have better opportunities. 3) Additionally, sectors related to exports have greater exposure, particularly in appliances, electronic devices, and shipping, which have a higher proportion of revenue from the United States, and should pay attention to tariff developments.
Author of this article: Liu Gang, Zhang Weihuan, etc., Source: CICC Insights, Original title: "CICC: Is it a good time to 'buy the dip'?", this article has been abridged.
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