Southbound net buying remained strong even on days of correction in HK stock market. While the valuation of the HSI is near decade-high, and market volatility would stay elevated, we believe the recent concerns over PBoC tightening is overdone, and expect HK market to maintain momentum in the short term.
- Southbound buying helped HK market outperform. HK stock market was among the best performing in the world YTD. In Jan 2021 alone, Southbound net buying is equivalent to 46% of the amount in the full year 2020. Policy is a main driving force behind the surge in Southbound trading, as Mainland annuities funds are now allowed to invest in HK stocks through Stock Connect.
- China tightening not a major concern yet. The HSI retreated sharply for four consecutively days by a total 6.2% during 26-29 Jan, due to fears over liquidity tightening by the PBoC. Considering that China’s economy is showing some signs and risks of slowing down in Q1 2021, it is rather unlikely for policymakers to tighten monetary policy now. PBoC governor Yi Gang said last week the central bank would not exit supportive measures prematurely.
- Reality check on valuation. While approvals of HK-stock annuities funds and surge in newly issued mutual funds in the PRC certainly help raise Mainlanders’ interest in HK stocks, the HSI is no longer cheap, trading at 13.1X of 2021E P/E, near decade-high. H-shares, however, still look attractive versus A-shares which are trading at 36% premium. Expect valuations of Hong Kong stocks to expand further moderately, with market turnover and volatility elevated, and corrections may occur more often.
- Preferred sectors: Internet, Consumer, Financials. In the short term, follow the tide, overweigh Internet sector which is sought-after by Mainland investors. With the “Two Sessions” of CPC (兩會) coming in early-Mar, policy-supportive sectors may outperform. We like Consumer, and suggest buying Solar glass sector on dip. In the medium term, we like financials (Insurance and Brokerage sectors) which are undervalued, lagging behind, and could enjoy re-rating on buoyant stock markets and higher bond yields.
- Tactical idea: potential new Southbound stocks. With Southbound inflows expected to remain strong in coming weeks, the half-yearly index review on the HSCI on 26 Feb 2021 warrants extra attention, as that will determine most of the changes in Southbound eligible stocks. We listed 20 stocks that may become Southbound-eligible.
- Key risks: 1) PRC policy to cool stock markets. If HK market shows signs of overheating or Mainland investors become too speculative, policymakers might cool the market by verbal warning or suspend approval of HK equity funds; 2) USD rebound. On chart, the USD is on the verge of a breakout of downtrend which may indicate further upside and exert pressure on EM stock.
