Guotai Junan Securities: Hong Kong stocks' earnings are still in the recovery phase, and the AH premium does not necessarily mean "mean reversion" in the short term

According to the Zhitong Finance APP, Guolian Minsheng Securities released a research report stating that although the overall performance of Hong Kong stocks has been weaker than A-shares since the second quarter, they remain optimistic about the current market for Hong Kong stocks, and the AH premium is not necessarily subject to "mean reversion" in the short term. Firstly, from the perspective of market ecology, the concentrated listing of "new economy" companies from A-shares in Hong Kong will further enrich the field distribution of listed companies in both markets and broaden the selection of funds. Secondly, the Federal Reserve is expected to welcome a rate cut window, and with the stabilization of the Hong Kong dollar exchange rate, the expectations of liquidity tightening in the Hong Kong market are likely to ease; at the same time, after a significant inflow of southbound funds this year, there is still demand and space for further allocation. Additionally, referring to the latest mid-term performance forecasts, the earnings of Hong Kong stocks are still in a recovery phase, and sectors such as new consumption also have supportive fundamentals beyond thematic catalysts.

The main viewpoints of Guolian Minsheng Securities are as follows:

Viewing the AH premium from a simple "mean reversion" perspective is debatable.

Since the beginning of the year, the Hang Seng AH premium index has continued to decline, and most industries have converged, with some investors using this as a timing basis for the two markets. However, upon review, Guolian Minsheng Securities believes that using the AH premium index to represent the relative performance of the two markets may have certain deviations. Firstly, the current number of listed companies and market capitalization ratio of AH in both markets is still relatively limited, and the style is biased towards cyclical and defensive, mainly consisting of state-owned "traditional economy" sectors such as industrial and financial industries; secondly, at the central level, since the launch of the Shanghai-Hong Kong Stock Connect until mid-2020, the AH premium index has mostly fluctuated in the 120-130 range, and the current level still has room for fluctuation compared to historical lows. Simply judging that the AH premium "must revert" based on the previous central level of 140 is not rigorous.

The consensus on the factors affecting the AH premium lies in liquidity, while the cognitive gap lies in fundamentals.

The existence of the AH premium essentially stems from the inability of the equity capital in both markets to circulate freely, and the core determinant of the AH premium level lies in the differences in liquidity between the two markets. They attempted to break down the key factors affecting the liquidity of Hong Kong stocks.

In terms of institutional construction, the lower downside protection in the Hong Kong stock market corresponds to a certain risk compensation. On one hand, the short-selling mechanism in the Hong Kong stock market is mature and transactions are active, coupled with the absence of price limits, which exposes investors to greater tail risks; on the other hand, considering various taxes, the trading costs in the Hong Kong stock market are relatively higher, affecting the actual returns for investors.

The continuous increase in the proportion of southbound funds will directly compress the discount space of Hong Kong stocks. From the perspective of transaction proportion, institutional investors account for over 60% of Hong Kong stocks, and the proportion of non-local institutional investors is high, with low-frequency trading also impacting the liquidity environment. The convergence of the AH premium also relies on international intermediaries buying in, and international intermediaries, especially overseas long-term funds, tend to focus on fundamentals and have strong allocation attributes. At the same time, in recent years, the influence of southbound funds on the AH premium has been accelerating, with significant convergence of the AH premium index after 2020 often accompanied by substantial inflows of southbound funds.

The weakening of the US dollar is beneficial for improving the liquidity of Hong Kong stocks, but it is not an excellent leading indicator. Under the currency regime, changes in the US dollar index do indeed affect the macro liquidity of the Hong Kong market. The continuous weakening of the US dollar this year may be a major reason for the convergence of the AH premium, but historically, there have been multiple instances of divergence between the US dollar and the AH premium, and in recent years, the divergence has become more pronounced. Currently, the US dollar index is no longer an effective leading indicator In the short term, the relative profit growth rate and changes in dividend yield between the A and H-share markets are important factors. In terms of profit growth, when the improvement in net profit of Chinese-funded Hong Kong stocks is greater than that of A-shares, the AH premium tends to converge. Coupled with the high proportion of institutional investors, strong fundamentals may enhance relative attractiveness; regarding dividend yield, when AH stocks are grouped by dividend yield, the AH premium rate significantly declines after the dividend yield exceeds 4%, with high dividends somewhat compensating for liquidity discounts.

Continue to be optimistic about the current market for Hong Kong stocks; the AH premium does not necessarily mean "mean reversion" in the short term.

Guolian Minsheng Securities points out that although the overall performance of Hong Kong stocks has been weaker than that of A-shares since the second quarter, it remains optimistic about the current market for Hong Kong stocks, and the AH premium does not necessarily mean "mean reversion" in the short term. Firstly, from the perspective of market ecology, the concentrated listing of "new economy" companies from A-shares in Hong Kong will further enrich the field distribution of listed companies in both A and H markets, broadening the selection for funds. Secondly, the Federal Reserve is expected to welcome a rate cut window, and as the Hong Kong dollar exchange rate stabilizes, expectations of liquidity tightening in the Hong Kong market are likely to ease; at the same time, after a significant inflow of southbound funds this year, there is still demand and space for further allocation. Additionally, referring to the latest mid-term performance forecasts, Hong Kong stock profits are still in a recovery phase, and sectors such as new consumption have not only thematic catalysts but also have supportive prosperity.

Risk Warning

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Federal Reserve rate cuts fall short of expectations: If the U.S. economy remains resilient and signs of rising inflation appear, the Federal Reserve's rate cuts may be further delayed, potentially affecting liquidity in the Hong Kong stock market.

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