Market Views: Are rising HK stocks reaching an inflection point?

Are Hong Kong stocks finally bouncing back or is it just a bear market rally that will soon fade? Fund managers weigh the drivers and risks.
Market Views: Are rising HK stocks reaching an inflection point?

Hong Kong stocks are currently enjoying their most impressive winning streak since late 2022, leaving investors to question whether this marks the beginning of a bull run or if it will merely echo last year's letdown.

As of Thursday, the Hang Seng Index (HSI) rallied 24% from the 14,961 points low in late January to the current level of 18,538. Year to date, the index is up 10.4%, closely following the best-performing Taiwan and Japan stocks in the region, while edging up against S&P 500.  

The rally is uncommon as Hong Kong stocks have struggled since 2020, when the Chinese government initiated a series of crackdowns on key sectors like property and internet, which are vital constituents of the HSI.

The HSI has plummeted 40% so far from its early 2021 highs.

While there is certainly a lot of room for more growth, market observers are also wondering whether this rally will be any different from the short-lived early 2023 run that faded quickly after China’s Covid-19 reopening lost momentum in its first three months.

There is indeed a pile of positive news. From policy loosening on home purchases in major Chinese cities such as Hangzhou, better-than-expected first-quarter corporate earnings and macroeconomic performance, to the expansion of the mainland-Hong Kong Stock Connect, and recent China-US diplomatic conversations.

On Thursday, the Hong Kong government also announced that it is working on an exchange-traded fund (ETF) with Saudi Arabia to track Hong Kong stock indices.

We asked fund managers whether they see fundamental improvements to support a more sustained winning streak, and which sectors investors should pay attention to.

The following responses have been edited for clarity and brevity.

Ben Bennett, investment strategist, APAC
Legal and General Investment Management

Ben Bennett

We think there are valid reasons for investor optimism to continue for now: relatively cheap valuations, weak investor sentiment, parts of the economy picking up and supportive policy messages, particularly after the recent Politburo.

However, there is still a high hurdle for China to emerge from its structural problems. Policymakers are reluctant to throw money at problems and reinflate the debt bubble.

Indeed, they have shown a willingness to absorb significant pain in the property sector in order to achieve a more sustainable economic outlook. And it will likely take several more years for the excess to be worked out.

This combination of near-term hope and long-term headwinds suggests that we’re in the middle of a bear market rally.

As we saw during Japan’s lost (two) decades, bear market rallies of 20% or more are quite common.

Indeed, the Hang Seng rallied more than 50% in late 2022 and early 2023, before falling again later that year.

For investors to fully regain their confidence, we’d need to see more structural improvements. Perhaps the long-awaited third plenum, now scheduled for July, could provide more evidence for this. But for now, we’re keeping our powder dry.

Caroline Maurer, head of China and specialised Asia strategies
HSBC Asset Management

Caroline Maurer

Hong Kong equity market’s rebound has been supported by mainland China’s better-than-expected first quarter macro data, especially in exports and accelerating manufacturing and infrastructure investment.

China’s supportive policy announcements - in property sector in particular - and resilient earnings with improving shareholder returns have also improved investor sentiment.

We observed Japan and US momentum unwinding and investors reducing underweight in Chinese and Hong Kong equities with undemanding valuation and more favourable positioning providing a better risk-adjusted return.

Property and consumption remain the main weak links of Chinese economy. Pragmatic policy delivery is important to keep up the recovery momentum after the Politburo meeting (at the end of April).

We focus on the first quarter results and property market data. Eventually, investors want to see positive earnings revision, capital expenditures (CAPEX) expansions and evidence that we are out of the deflationary cycle for a more sustainable rally.

We continue to focus on China’s high-quality growth companies listed in Hong Kong, and companies that can gain market share and economy of scale. We try to avoid stocks with earnings downward revision risk amid a weak macro environment.

Sector wise, we prefer communication services, information and technology, energy and material that may offer high visibility in both revenue and earnings growth. New generative AI tools create significant opportunities for technology hardware and software sectors in the future.

We also like some electric vehicle and pharma companies with technology edge and production capability.

David Chao, global market strategist, Asia Pacific ex-Japan

David Chao

It makes sense that Hong Kong stocks are getting attention. Even after the year-to-date rally, H-shares continue to trade at an over 40% discount to their A-share peers.

Recent economic indicators are encouraging. First-quarter growth was better than expected, and tourist arrivals over the Labour Day golden week holiday show the city is still appealing.

The economic environment in China and the US is also supportive. There also appears to be a rotation out of popular but crowded investment themes such as AI, Taiwan, Japan and the US markets into better-value propositions and cheaper stocks.

Last month, the China Securities Regulatory Commission announced a raft of supportive policies including an expansion of the Stock Connect scheme. This should drive more mainland capital into Hong Kong’s stock market and help close the valuation gap.

Fundamentally, I’m much more optimistic that Chinese growth can bolster the market in the longer term. This should convince domestic and international capital to pivot from a tactical to a longer-term allocation.

The next major catalyst for Hong Kong stocks will come from consumer indicators, and here we may have some good news.

Preliminary consumer data on Chinese travel over the golden week holiday shows robustness. According to the National Bureau of Statistics, the March consumer confidence index has shot up to a one-year high.

We are seeing the first green shoots of re-accelerating growth in mainland China and Hong Kong. Economic growth in both markets is exceeding expectations and global growth appears to be re-accelerating.

Christina Chung, senior portfolio manager
Allianz Global Investors

Christina Chung

The improved Hong Kong performance is due to a number of factors.

First, the decision in January by the Chinese government to mobilise the “national team” through significant buying of onshore ETFs provided a significant confidence boost by helping to set expectations of a market floor.

Subsequently, the most recent quarterly results season has also been reassuring with a number of high-profile “beats”.

While top-line growth has generally been muted as expected, tighter cost control has fed through into improved bottom line profitability. Alongside the improved earnings picture has been a notable increase in dividend payouts and share buybacks.

From a fundamental perspective, there appears to be room for this to continue.

The overall dividend payout ratio of around 30% for offshore China stocks, for example, is relatively low in a global context, despite the high levels of cash on many corporate balance sheets.

The amount of equity issuance has also declined significantly. If this is the start of a more structural change, then the scene may be set for a more favourable balance of equity demand and supply going forward.

Areas we currently think represent interesting growth opportunities include domestic consumption, focusing on the rising market share of domestic brands as consumers seek value for money; infrastructure investment in public utilities and areas such as upgrading China’s national power grid; the continued push for enhanced self-sufficiency in key technologies; rising demand for urbanisation upgrades such as smart city developments, logistics, waste treatment and renewable energy.

Yu Chenjun, deputy chief investment officer, equities
Value Partners

Yu Chenjun

The recent strong performance of the Hong Kong stock market can be attributed to the following factors: recovery of the Chinese economy; increased support from Chinese economic policies; relative undervaluation of Hong Kong stocks.

Based on these reasons, we hold an optimistic outlook for the Hong Kong market.

Regarding sector preference, we adhere to a bottom-up stock selection approach and follow the "3R" principle of "right business, right people and right price" when choosing investment targets.

On one hand, the Chinese economy is still undergoing its continuous transformation and upgrading, and we continue to seek investment targets that represent the future "high-quality" sectors of the Chinese economy, such as internet, hard technology, high-end manufacturing, and high dividend stocks.

On the other hand, we also pay attention to opportunities for turnaround in struggling sectors.

For example, opportunities arising from the recovery in the entire real estate industry chain due to the stabilisation and rebound of the real estate market, and opportunities for sector leaders to reverse their performance due to the recovery in consumer demand.

Nicholas Yeo, head of China equities

Nicholas Yeo

The recent rally appears more to be a technical rebound given how cheap the market is currently, with valuations at historic troughs, but its sustainability will depend on earnings outlook for the rest of the year.

So far, companies sound optimistically constructive.

Our focus remains on companies with higher earnings visibility coupled with those that can do more on higher payout our buyback, including state-owned enterprises (SOEs) and private enterprises. Internet companies have done quite a bit of buybacks year-to-date.

As policy is becoming incrementally more accommodative, more material support via larger-than-expected fiscal spending and additional help for the property market would go a long way to materially improve sentiment in China.

That said, it is clear from last month’s National Congress that the government intends fiscal support to be disciplined.

Zhang Jun, director, head of research
China Asset Management (Hong Kong)

Zhang Jun

Our outlook suggests that the Hong Kong stock market has passed its inflection point and will likely experience upward fluctuations in the future.

We are particularly optimistic about sectors that are currently undervalued and have growth potential, such as pharmaceuticals and consumer goods.

We also focus on traditional economic state-owned enterprises and Internet technology companies that are improving their competitive landscape and are able to continuously increase dividends and buybacks.

The extent of market recovery and the inflow of foreign capital will critically depend on whether the Chinese economy can sustain its recovery trajectory.

We believe this will be a key determinant of future market performance.

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