CICC: Where is the "ceiling" of the Hong Kong stock index?

Since the beginning of this year, the Hong Kong stock market has remained active and has outperformed major global markets, especially significantly surpassing the A-share market. However, entering July, the situation has clearly reversed. Compared to the A-share market, which has surged to a "ten-year high," the Hong Kong stock market "appears" much more sluggish, at least in terms of the index "stagnating." After the Hang Seng Index broke through the 25,000-point mark, it has been consolidating around this level for the past month, struggling to break through effectively, and has remained basically flat since mid-July (the Hang Seng Index has risen 3%), significantly underperforming the A-share market during the same period (the Shanghai Composite Index rose 9.2%, and the ChiNext Index surged by 20%). In fact, even since April, when the Hong Kong stock market began to recover, it has still underperformed among major global markets, and the Hang Seng Tech Index has not yet recovered the losses since the end of March.

Chart: Despite the recovery of the Hong Kong stock market after the equal tariffs, it has indeed underperformed within the global market.

Source: Bloomberg, CICC Research Department

In a sense, the recent dullness and underperformance of the Hong Kong stock market is not surprising and is even within expectations. Over the past month, we have continuously reminded investors that for the index to break through effectively, more catalysts exceeding the previous "high base" are needed, thus suggesting a focus on structural market conditions. At the same time, we pointed out that after the AH premium broke through the "invisible bottom" of 125%, the Hong Kong stock market might underperform in the short term.

Chart: Although the Hong Kong stock market has outperformed the A-share market year-to-date, the A-share market has shown stronger performance over the past month.

Source: Bloomberg, Wind, CICC Research Department

So, what are the main reasons for the recent underperformance of the Hong Kong stock market? Can the recent strength of the A-share market spread to the Hong Kong market, or is the Hong Kong market the leading indicator? What is the reasonable central point for the Hong Kong stock market, and how can we calculate the static "upper and lower limits"?

Why has the Hong Kong stock market lagged recently? Liquidity (Hibor rising), fundamentals (earnings downgrades), valuation (AH premium too low)

We believe that the recent underperformance of the Hong Kong stock market compared to the A-share market is mainly due to three factors: liquidity, fundamentals, and valuation.

► Liquidity: Hibor has risen rapidly, and liquidity is marginally tightening. In just one week, the Hibor rates for overnight to one month have surged from near zero to close to 3%, indicating that interbank funding in Hong Kong is clearly tightening, which inevitably spills over to the secondary market through various channels. In our report "How Does Hibor Affect the Hong Kong Stock Market?", we pointed out that under the linked exchange rate system, the liquidity injection and absorption operations of the Monetary Authority are passively responsive and automatically triggered. In fact, after the Hong Kong dollar touched the weak side guarantee of 7.85 in mid to late June, the Monetary Authority began to gradually absorb liquidity. However, since the absorption speed is slower than the liquidity injection speed in early May, and the transmission from quantity to price requires a process, the result has been that the rise of Hibor over the past two months has been very slow The Hong Kong dollar has also been unable to break away from the weak side guarantee of 7.85. Until recently, the nonlinear changes after breaking the threshold, combined with the amplification of potential carry trade reversals, triggered a sudden rise in Hibor and the Hong Kong dollar. Although the reverse disturbance from the rise in Hibor is not significant, it is still not comparable to the loose environment of the past few months.

Chart: Recent overnight Hibor has rapidly risen to nearly 3%, with overall liquidity tightening.

Source: Bloomberg, Wind, CICC Research Department

In contrast, the liquidity in the A-share market has been very ample recently, with daily trading volume exceeding 3 trillion yuan at one point, and the financing balance also surpassing 2 trillion yuan. In addition to trading funds, the positive feedback effect of activating household deposits and entering the market through wealth management is also continuously manifesting. For example, the M1 growth rate in July increased by 5.6% year-on-year, showing a significant rise, and the trend of fixed-term deposits has also shown a turning point for the first time since 2023, reflecting that household fixed deposits and bank wealth management products have not been reinvested upon maturity. Deposits flowing into brokerage margin accounts and the rising growth rate of non-bank deposits have become potential market entry funds. According to estimates from CICC's banking team, the new excess savings of households from 2022 to 2024 is about 5 trillion yuan. In the active environment of the A-share market, the spillover enjoyed by the Hong Kong stock market will also be "discounted," although the trend of southbound inflows has not reversed, it has recently slowed down.

Chart: The financing balance of A-shares is close to historical highs, with optimistic narratives like "deposit migration" driving the market up.

Source: Wind, CICC Research Department

Looking ahead, with Federal Reserve Chairman Jerome Powell "turning dovish" at the Jackson Hole meeting[1], investors are looking forward to the Fed's interest rate cut in September, which is expected to support the performance of the Hong Kong stock market in terms of liquidity. We believe that the warming expectations of Fed rate cuts will indeed help the liquidity of the Hong Kong stock market in the short term, but it cannot be regarded as a single and absolute dominant factor. In our report "Is the Fed's Rate Cut a Benefit or a Disadvantage for Us?", we mentioned that to see the impact of rate cuts on U.S. Treasury yields and the dollar, it is crucial to distinguish between recessionary rate cuts and preventive rate cuts. Taking the recent rate cut cycle from September to November last year as an example, the starting point for rate cuts was actually the low point for U.S. Treasury yields and the dollar, and the upward trend continued throughout. The 2019 rate cut cycle was similar. Moreover, domestic factors have a greater impact on market trends. For instance, during the 2024 rate cut cycle, the Chinese market, including the Hong Kong stock market, has actually corrected from the October peak, and the fluctuations during the 2019 rate cut cycle are sufficient proof Chart: The beginning of the Federal Reserve's interest rate cuts in September 2024 marks the low point for the 10-year U.S. Treasury yield, which subsequently rises during the rate cuts in September to November.

Source: Bloomberg, Wind, CICC Research Department

Chart: For the Chinese market, interest rate cuts are not a decisive factor; domestic fundamentals have a greater impact.

Source: Bloomberg, Wind, CICC Research Department

► Fundamentals: Hong Kong stocks' earnings continue to be revised downwards. During the recent interim report period, market consensus has continuously revised down the Hang Seng Index's earnings for 2025 to negative growth (-1.4% vs. 2024's 17.8%). Although intensified competition in the takeaway sector has significantly dragged down the earnings revisions for JD.com, Alibaba, and Meituan, nearly 60% of the 85 companies within the Hang Seng Index are experiencing earnings downgrades, indicating that this is not an isolated phenomenon and is consistent with the weakening economic data. From the index breakdown, of the 5% increase in the Hang Seng Index since July, earnings contributed -0.5%, and the overall 26% increase this year has primarily been driven by risk premiums (contributing over 15%).

In contrast, the earnings downgrades for A-shares are not significant, and there has even been a slight upward adjustment. Additionally, due to last year's low base effect, market consensus expects the MSCI China A-share Index's earnings growth rate for 2025 to be 10%, better than the -5.8% for 2024, which contrasts with the decline in Hong Kong stocks this year compared to last year. Although this is related to last year's low base for A-shares and the low proportion of internet companies, it at least appears to show improvement in surface numbers.

Chart: The earnings growth rate for the Hang Seng Index in 2025E has been revised down to -1.4%.

Source: FactSet, CICC Research Department

Chart: In contrast, the MSCI China A-share Index's earnings growth rate for 2025 is close to 10%.

Source: FactSet, CICC Research Department

Chart: Analyzing the market performance since July, we find that earnings have a negative contribution to the Hang Seng Index.

Source: Bloomberg, CICC Research Department

► Valuation: AH premium reaches the "invisible bottom" of 125%, attractiveness of Hong Kong stock dividends declines: Although dividends are only part of the various allocation directions of Hong Kong stocks, and not all investors need to pay dividend tax (20% for H shares, up to 28% for red chips), for most investors except for insurance, the decline of AH premium below 125% means a decrease in attractiveness after tax deductions, which is consistent with our previous indication in "How Low Can the AH Premium Go?"

Chart: Recent AH has remained low, once breaking through the "invisible bottom" of 125%

Source: Wind, CICC Research Department

So who is the leading indicator for whom? Can the recent strength of A shares spill over to Hong Kong stocks?

From a fundamental perspective, the current round of Hong Kong stocks is "leading," having led for nearly a year, and the recent underperformance also indicates limited fundamental catalysts; however, from a liquidity perspective, A shares have recently begun to "lead." If the resonance between funds and the market continues to strengthen, it is likely to spill over some to Hong Kong stocks, but this kind of "filling the pit" thinking may correspond more to the later stages in terms of time and the overdrawn stage in terms of degree.

► From a fundamental perspective, the leading position of Hong Kong stocks since the beginning of the year is precisely a direct reflection of the fundamentals (overall macro fundamentals lack returns, highlighting structural return highlights). As we mentioned earlier, under the combination of "plenty of money" (abundant funds) but "few returns" (asset scarcity), funds will inevitably chase quality assets, whether it is stable return dividends or growth returns with structural highlights, both of which are more prevalent in Hong Kong stocks (AI internet, new consumption, and innovative drugs, reflected in the overall market ROE remaining flat but some industries' ROE starting to rise). This also explains the continuous significant inflow from the south since the beginning of the year (cumulative inflow exceeding HKD 950 billion, significantly surpassing the HKD 800 billion for the entire year of 2024). Therefore, from a fundamental perspective, Hong Kong stocks are "leading," having led for a year, and the recent underperformance precisely indicates limited fundamental catalysts.

► However, the logic of A shares has quietly changed recently, driven more by liquidity and less related to fundamentals. Additionally, as mentioned above, Hong Kong stocks are also being "dragged" by their own profit downgrades and tightening liquidity, making underperformance inevitable. But the question is, if A shares continue to strengthen under the resonance of funds and the market, can it spill over to Hong Kong stocks and become a "leading" indicator for Hong Kong stocks? If this hypothesis holds, it is likely to spill over some, but it may correspond more to the later stages in terms of time and the overdrawn stage in terms of degree.

Comparing the Hang Seng Index with profit trends, there are not many instances of profit downgrades while the index rises, and the only real match is the "water buffalo" market from the end of 2014 to mid-2015. At that time, the continuous rise of A shares also triggered the "catch-up" market of Hong Kong stocks in April 2015, but in terms of time and degree, it was basically nearing its end Because at that time, investors were more inclined to seek corresponding "bargains" in the Hong Kong stock market under the already expensive environment of the A-share market, but this "filling the pit mentality" itself appeared in the later stages and was prone to overextension. Therefore, relying on liquidity-driven market trends, the A-share market is "leading."

Chart: Significant inflow of southbound funds year-to-date, but recent fluctuations have occurred.

Source: Wind, CICC Research Department

Chart: Historically, the phase of profit downgrades but index rises is not common in the Hong Kong stock market, with a typical period being from late 2014 to early 2015.

Source: Bloomberg, CICC Research Department

Chart: However, in reality, during the A-share "water buffalo" market from 2014 to 2015, the Hong Kong stock market struggled to keep up in terms of duration or increase.

Source: Wind, CICC Research Department

What is the reasonable central point of the Hang Seng Index? How to calculate the "upper and lower limits" in a static manner?

Over the past few months, we have maintained our judgment on the Hong Kong stock market at a baseline of 24,000, with an optimistic range of 25,000-26,000. Looking back, the market had some upward movement earlier, but it never formed an "effective breakthrough." Against the backdrop of a significant rise in the A-share market and heightened sentiment, we have not significantly raised our target levels, mainly because both the overall and structural methods still require some "conditions."

1) Overall method: Profit downgrades, high sentiment. In the absence of clear profit prospects, valuation, especially the risk premium within it, is key to determining levels. We have consistently used a dynamic weighting of Chinese government bonds and U.S. Treasury bonds (adjusted according to the proportion of southbound trading, currently around 35%-40%) to calculate the risk premium of the Hong Kong stock market. Looking back, this method has proven very reliable during last year's drop in September and this year's early DeepSeek and "reciprocal tariffs" declines. Currently, the risk premium of the Hang Seng Index after dynamic weighting is 5.8%, which is not only lower than the historical lows since October last year but is actually a new low since the market peak in early 2018. If we use the 6% that has been tested multiple times since 2018 as a lower limit for calculation, the Hang Seng Index level is around 24,000.

2) Structural method: Breakthrough requires internet cooperation. The flaw of the overall method is that it cannot depict the structural market of the Hong Kong stock market this year. Therefore, we further broke down the risk premiums of major sectors to highlight the differences in structural drivers. After disassembly, it can be found that the index peak at the end of March was mainly driven by the internet, while the current round of index peaks is more driven by the financial cycle and new consumption innovative drugs Specifically, the risk premium for the technology and internet sector is 1.9%, still higher than the 1.2% at the end of March, while the risk premium for e-commerce at 4.7% is significantly higher than the 3.3% at that time; in contrast, the risk premium for new consumption and innovative drugs is 0.6%, close to the level after the pandemic was lifted at the end of 2022, and the risk premium for the banking cycle is 8.0%, which is significantly lower than the 9.1% at the peak of housing prices in 2021. If the financial cycle, new consumption, and innovative drugs maintain low premiums, while the internet and e-commerce return to the emotional level at the end of March, it could help the Hang Seng Index stabilize above 26,000 points.

Chart: Under the overall fundamental benchmark assumption, if profits remain unchanged and the risk premium stays around 6%, it corresponds to the Hang Seng Index near 24,000 points.

Source: Bloomberg, Wind, CICC Research Department

Chart: Structural method: The risk premiums of the current major categories are already at multi-year lows, so further breakthroughs require the cooperation of the internet sector.

Source: FactSet, Wind, CICC Research Department

Some have raised the question of whether the risk premium calculated above is problematic due to the risk-free interest rate used. After all, in the current environment where the interest rate differential between China and the U.S. has diverged significantly, a "small change" in the weighted ratio of China and U.S. interest rates can lead to a "big difference" in the risk premium, and there is much "room for discussion" on what the reasonable proportion of Chinese bonds should be (i.e., the pricing power of Chinese assets) (for example, should we consider the potential for further increases in southbound investments? Should we consider other types of investors outside of southbound?).

This doubt is indeed reasonable, so we follow this line of thought to calculate the potential "upper and lower limits" of the index in a static environment (assuming profits and the risk-free interest rate do not change significantly): 1) Assuming the pricing proportion of southbound investments increases to 50%, then Chinese bonds and U.S. bonds are "fifty-fifty," corresponding to a Hang Seng Index level of 26,000, which is basically consistent with our optimistic scenario; 2) If we make a more extreme deduction and further increase the proportion of Chinese bonds to 100%, it corresponds to a Hang Seng Index of 30,000 points; conversely, if the proportion of Chinese bond pricing is reduced to 0%, it corresponds to a Hang Seng Index of 22,500. A 100% Chinese bond (30,000 points) or 100% U.S. bond (22,500 points) pricing is obviously unrealistic in reality, but its significance is to provide a reference "upper and lower limit" due to pricing power discrepancies in a static environment.

Chart: Calculating the "upper and lower limits" of Hong Kong stock index points based on different risk-free interest rate weighting assumptions.

Source: Wind, Bloomberg, CICC Research Department

Current Strategy: Hong Kong Stocks Lagging in the Short Term, Long-Term Structural Advantages; Structure Outperforms Index; Focus on Overseas Mapping Chains

Considering the recent changes in the internal and external market environment, as well as the calculations of the index "upper and lower limits" mentioned above, we believe:

► Hong Kong stocks are lagging in the short term due to liquidity. The liquidity advantage of A-shares will cause Hong Kong stocks to lag in the short term, especially with earnings downgrades and the low AH premium dragging down performance. If the liquidity of A-shares and market resonance further strengthens, it will partially spill over to Hong Kong stocks, but more so in the mid to late stages and to a degree that is overdrawn. Therefore, if one only participates in liquidity games in Hong Kong stocks without new fundamental support, it is advisable to be cautious.

► However, long-term advantages lie in structural benefits. Unless there is a trend change in the current macroeconomic or credit cycle environment, Hong Kong stocks can still provide stable returns with high dividends and structural growth returns, which remain their main long-term attractions, such as AI internet, innovative pharmaceuticals, new consumption, and robotic components.

► Structure outperforms the index. Several prominent features of the Hong Kong stock market this year are: 1) structure is far stronger than the index; 2) main lines are constantly rotating. This means that if each round of structure is accurately captured, it will provide returns far exceeding the index; conversely, if each round of structure is misjudged, it will significantly underperform. In our report "How to Find Clues for Industry Rotation?", we constructed a simulated portfolio, assuming that from September 24 last year, each round of style was roughly "on point" (September 24 allocated to non-bank, DeepSeek market allocated to internet technology hardware, and after the "equal tariffs" in early April allocated to new consumption and innovative pharmaceuticals), the excess return compared to the Hang Seng Index has approached 160% to date, indicating how strong the structural market and Alpha opportunities in Hong Kong stocks have been since the beginning of the year.

However, conversely, if investors misjudged but chose to chase high prices, for example, allocating to non-bank after last year's National Day, chasing internet and technology hardware in March, and reallocating to new consumption in July, despite still achieving about 20% absolute return since September 24 last year, they underperformed the benchmark Hang Seng Index by nearly 18%. Therefore, the long-term correct structural direction must also be bought at the right position; "don't get too carried away" chasing high prices. In the short term, from our constructed "crowding" indicator, the crowding in internet, e-commerce, new consumption, and banking is lower, making it a more suitable time to enter.

Chart: Rapid rotation of Hong Kong stocks this year, suggesting attention to trading crowding in various sectors and themes

Source: Wind, CICC Research Department

► Opportunities from an overseas mapping perspective. In a market environment dominated by liquidity and sentiment, if domestic fundamentals and policies cannot provide more support, then overseas demand and mapping chains are also a configuration idea, such as 1) computing power, robotics, Apple supply chain narratives, and 2) furniture and home goods and non-ferrous metal mapping chains driven by U.S. real estate and investment demand after the Federal Reserve's interest rate cuts Chart: From late 2014 to early 2015 was the phase of leveraging in the secondary market. Although Hong Kong stocks also rose, the increase and duration were difficult to keep up with A-shares.

Source: Wind, CICC Research Department

Authors: Liu Gang, Zhang Weihuan, Source: CICC Insights, Original Title: "CICC: Where is the 'Upper Limit' of the Index?"

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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 your own risk