Funds flow from high places, Hong Kong stocks only lack catalysis

Under the huge fluctuations in the Japanese and US stock markets, the liquidity crisis caused by carry trades has come to an end. Although it is difficult to quantify the scale of borrowing in Japanese yen over the past 8 years, the panic has at least come to a temporary halt. As Chinese assets are under-allocated in foreign asset allocation, the impact on A/H shares last week was limited. However, due to the violent deleveraging of carry trades this time, coupled with weakening US economic data, many funds have realized that their future positions cannot be too crowded. Otherwise, just like the case of NVIDIA triggering a leverage explosion in the Japanese stock market, carry trades have been profitable in the first 7 months of this year. However, when a liquidity crisis occurs, all gains can be wiped out in just one day. In other words, after this round of liquidity crisis, the old trading patterns in the market have been shaken, and traders are no longer daring to concentrate too much on crowded trades. This has also provided an opportunity for undervalued assets to be re-examined, such as the Hang Seng TECH Index ETF (513180.SH) which has corrected for nearly 3 months. In the Asian market, there is a certain seesaw relationship between the Japanese and Hong Kong stock markets in attracting inflows. Currently, some funds are no longer heavily allocated to Japanese stocks as before. Funds flowing out of the Japanese market will naturally turn their attention to the Hong Kong stock market on the other end of the seesaw. Among Hong Kong stocks, undervalued internet stocks with active shareholder return programs undoubtedly become the first choice for inflows. Opportunities arising from the widening valuation gap After the 20% surge in Hong Kong stocks in May, the Hang Seng Index's price-to-earnings ratio was 9 times PE, while the Nikkei 225 Index's price-to-earnings ratio was 16 times PE. Up to now, the Nikkei 225 Index's price-to-earnings ratio is 20 times PE, while the Hang Seng Index is only 8 times PE, making the valuation gap between Hong Kong and Japanese stocks even larger than in May. (Comparison of Hong Kong and Japanese stock valuations after the May surge) Even with the recent 30% plunge in Japanese chip stocks, the average PE is still at 30 times, while Tencent, the anchor stock of Hong Kong, is valued at only 13 times PE next year, in addition to a billion-dollar buyback + stable annual growth. Therefore, after the global funds reshuffle, funds are re-focusing on investment risks. From a valuation perspective, both overall market and individual stock valuations, it is clear that Hang Seng TECH in Hong Kong is more attractive than the Nikkei 225. As the valuation gap widens, the crowding level of Japanese stocks is also a key point. There is a saying in the investment world: "Don't go where the crowd is," especially when past trading logic may have the chance to be reversed in the future. And now, we are just at this critical point, with uncertainties in the US election + US rate cuts + Japanese rate hikes being the main reasons triggering this global reshuffling trend According to CICC statistics, the allocation of various active funds managed by EPFR to Chinese stocks has decreased from a high of 14.6% in October 2020 to a historical low of 5.5% by the end of June. Therefore, even if there is another wave of unwinding in the future, Chinese stocks that are extremely under-allocated will still be a safe haven. On the contrary, in this environment, if there are slightly positive changes in marginal factors, the upside potential could be significant and rapid, just like the sharp rise in April and May. Therefore, the valuation and odds of Hong Kong stocks are now appropriate, lacking only a catalyst, a reversal in fundamentals. If the Fed successfully cuts interest rates in September, it will be beneficial for the appreciation of the RMB, opening up more room for domestic interest rates. If policies can continue to exert force at this opportunity, it will provide more support for subsequent fund inflows and market rebounds. Referring to the sharp rise in Hong Kong stocks in April and May, considering the holding experience during the process, intervening through index ETFs can be said to be no less competitive than most of the heavyweight stocks in the index. For example, the Hang Seng Tech Index ETF (513180.SH) rose by over 23%, which is similar to the largest elastic stock in the index, Meituan. Second, Hang Seng Tech is sufficiently undervalued with high odds Although the overall return on Hang Seng Tech has not been good in the past 2 years, there have been 2-3 significant rallies every year. The most important thing in investing in Hang Seng Tech is to seize the opportunity when the market changes. From the perspective of the components of Hang Seng Tech, it is more appropriate to intervene through ETFs at this stage, because the two factors that have recently dragged down the Hang Seng Tech Index ETF (513180.SH) are reversing, making it a good trading opportunity. 1. The top ten heavy-weighted stocks account for 69% of the index, with the top 6 holdings, Tencent, Meituan, Xiaomi, Alibaba, JD.com, and Kuaishou, all having clear buyback plans. However, July and August are the silent period for buybacks before the disclosure of performance in the Hong Kong stock market. During this period, companies are not allowed to repurchase shares, increasing downward pressure on stock prices. Therefore, it can be seen that after Tencent and other major index-weighted stocks entered the buyback silent period, the performance of Hang Seng Tech in the past month has been weaker than during the buyback period. However, in the past two weeks, internet stocks have resumed buybacks after disclosing their performance, which is a good entry point for investors. Looking at individual stocks, Tencent, the largest heavy-weighted stock, as the leader of Hang Seng Tech, has not fallen much in the past 3 months Over the past 2 years, whenever Tencent enters the quiet period for repurchases, its performance is relatively poor. However, currently, even during the repurchase quiet period, the reduction in the number of shares by the major shareholder from South Africa has no impact on the stock price. The inflow of funds from the south has already surpassed the reduction in shares by the major shareholder from South Africa. According to statistics, from July 15 to August 2, the major shareholder from South Africa reduced holdings by approximately HKD 2.93 billion over three weeks. In the past 20 days, funds from the south have flowed into Tencent by a net amount of HKD 15.4 billion. The proportion of Tencent held by funds from the south has also increased from 8.8% in March to 10%. During the adjustment process in recent months, funds from the south have been taking the opportunity to increase their holdings in Tencent, and their positive attitude towards the funds is unquestionable. With Tencent's performance recovery and repurchase in the future, the two major buyers, Tencent's repurchase + funds from the south, can provide strong support for the Hang Seng Technology Index. The probability of a stock price increase is even greater. Looking at Li Auto, a heavily weighted stock, it has been the biggest decliner in the past 3 months, with a decline of over 30%. However, after this round of sharp decline, the valuation has been greatly digested from a PE ratio of 25 times in May to the current 13 times PE. In July, Li Auto's deliveries also returned to 50,000 vehicles, showing some improvement in fundamentals. At this stage, the downside potential for further decline is very limited, and the upside potential is also considerable. Therefore, after the valuation drag on individual stocks is over, the upward pressure on Hang Seng Technology is also decreasing. The repurchase after the performance of Internet stocks will bring even greater upward momentum. This is similar to the conditions before the market started in April, and with a slight marginal change, a new round of market trends can be initiated. Conclusion Overall, whether from a valuation perspective or from a shareholder return perspective, the Hang Seng Technology Index ETF (513180.SH) is more worth allocating to now than it was before the big rise in April this year. There are also many potential catalysts, such as the possibility of Alibaba entering the Hong Kong Stock Connect in September, a total inflow of HKD 150 billion from the south into Hong Kong stocks in the past 3 months, and funds flowing from high to low valuations in Japanese stocks. With the combination of these factors, now is the right time for Hong Kong stocks to seize the opportunity for a reasonable pricing recovery