How can Hong Kong stocks emerge from a "triple bottom"?

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Shenwan Hongyuan believes that, under the combined effects of continued decline in institutional allocation, bottoming and stabilization of fundamental expectations, and deep valuation corrections in technology growth sectors, the Hong Kong stock market is currently in a "triple-bottom" area, with basic conditions for a bottom-building rebound.

In a report released by the Shenwan Hongyuan strategy team on July 16, both macro catalysts and industry narratives have recently shown positive changes, which may drive the market out of its bottom. The Hang Seng Index fell 10.73% in the first half of 2026, while the Hang Seng Tech Index dropped as much as 18.92%. At the industry level, only industrial, conglomerate, and financial industries recorded positive returns, while materials and non-essential consumption sectors dropped over 25%.

According to Shenwan Hongyuan's ERP model, under a neutral scenario, the potential return space for the Hang Seng Index within the year is 15.40%, corresponding to an assumed earnings growth rate of 2% for 2026, and a 10-year U.S. Treasury yield of 4.30%. Meanwhile, the amount of outstanding short positions in HK stocks is at extreme historical highs. If the market turns, short covering could provide extra elasticity for the index to rise.

Triple Bottom One: Sharp Decline in Institutional Allocation

Allocation to Hong Kong stocks by mainland funds saw a pronounced retreat in the first half of 2026. Southbound funds net inflows in the first half were only about HK$301 billion, less than 22% of the full year 2025 and less than 38% of the full year 2024; the daily average trading volume through Stock Connect as a proportion of total market turnover dropped quickly from the historical high of about 25% in 2025 to around 21%.

Actively managed public mutual funds are an important driver of the downward allocation to HK stocks in this cycle. By the end of Q1 2026, actively managed public funds primarily invested in A-shares but also allowed to invest in HK stocks had reduced their HK stock holdings proportion from the high of nearly 20% in mid-2025 to 13.9%, about 6 percentage points lower, with a clear trend of "redemption in HK, return to A-shares." Shenwan Hongyuan expects this proportion to continue declining in Q2, possibly approaching the 10% level seen in 2022-2023.

The selling pressure is also spreading to long-term funds. Mainland HK stock tech-theme ETFs switched to net redemption since April, with net redemptions in June expanding further to over RMB 40 billion for the month.

As for overseas investors, by the end of May, the allocation ratios for China and Hong Kong assets in actively managed emerging market funds and Asia-Pacific funds had dropped back to levels seen at the end of August 2024, while allocations to South Korea and Taiwan equities have reached or approached historical highs.

Triple Bottom Two: Fundamental Expectations Stabilized After May

EPS expectations for the Hang Seng Tech Index underwent their largest downward revisions in history around mid-May 2026, mainly because net profits at internet platform companies continued to be hit by factors like "takeout subsidies," "hyper-competitive behavior," and increased AI capital expenditure. However, as Q1 earnings season concluded in late May, EPS forecasts for the Hang Seng Tech Index became noticeably more stable.

From an industry point of view, most major downward adjustments to earnings forecasts were concentrated in the first four months of the year, becoming stable after May. The largest downward revisions were in retail chains and real estate sectors, while materials, energy, finance, and healthcare sectors overall saw upgrades in earnings forecasts.

Notably, there were diverging combinations such as "upward earnings revisions but share price declines" in healthcare and non-bank financial sectors; for non-e-commerce platform companies—including media/entertainment, consumer services, business services—the drop in stock prices was several times the magnitude of corresponding downward earnings revisions, showing especially sharp valuation corrections.

Triple Bottom Three: Deep Valuation Trough for Technology Growth

In terms of valuation, Shenwan Hongyuan pointed out that the current market exhibits "technology growth sector valuations falling to historical lows, broad index valuations also obviously declining."

Hang Seng Tech Index ERP nearly hit the level at the end of 2024 during the sharp market decline in June; comparing percentile valuations of the Hang Seng industry indices since 2020, tech, consumer, and healthcare segments in late June had valuations lower than those before the September 24, 2024 market rally, revealing that this round of valuation bottoms is mainly characterized by a deep trough in tech growth and domestic demand sectors.

Broad indices have not been spared either. Hang Seng Index ERP surged to about 6.5% in late June, the last time reaching such a level was early April 2025 during global trade friction shocks.

Extreme Short Positions May Become a Catalyst For Rebound

Shenwan Hongyuan believes that the most distinctive structural feature of the HK stock market bottom this time is the simultaneous high levels of short selling and trading activity. Excluding Stock Connect trades, short selling as a proportion of total market turnover has held above 20% for months; the amount of outstanding HK stock shorts has kept climbing since breaking the historical upper limit at the start of 2025, now at unprecedented extremes.

The report attributes this to four factors:

First, average daily turnover in HK stocks expanded from HK$131.8 billion in 2023 to about HK$260.5 billion in the first half of 2025-2026, so market size expansion naturally pushed up short sale volumes;

Second, the percentage of short selling in total trading itself increased;

Third, structured product volumes surged – average daily turnover of derivative warrants in 2025 rose by 48% year-on-year, daily turnover for bull/bear contracts rose by 59%, and daily turnover for bull/bear contracts in the first half of 2026 still maintained a 35% year-on-year increase, requiring market makers to short the spot market for hedging;

Fourth, some regional hedge funds have adopted "long AI hardware, short China software and consumption" strategies this year, contributing notably to short sale volumes in the HK market.

Shenwan Hongyuan points out that if fundamentals or global industry preferences reverse, closing out the massive short positions could provide significant upward elasticity for the market.

Macro & Industry Catalysts to Exit the Bottom

At the macro level, Shenwan Hongyuan notes that with the absence of southbound investors, HK stocks' sensitivity to U.S. Treasury yields and global liquidity has clearly increased, the negative correlation between U.S. Treasuries and HK stocks is at a significant level. Meanwhile, the State Council has recently approved the "15th Five-Year Consumption Expansion Plan," focusing on emerging needs in elderly care, childcare, culture/tourism, and healthcare, and put forward arrangements to promote service consumption and develop digital consumption. Service and new consumption fields are distinctive sectors in Hong Kong stocks, so implementation of these policies will help improve fundamental expectations.

At the industry level, Shenwan Hongyuan believes that the narrative shift within the technology sector could be key to changes in global market trading themes for the second half of the year. On one hand, global AI hardware trading is now constrained by tightening financing, concerns about surplus computing power, unclear commercialization prospects, and crowded trades, raising the probability of a trend reversal; on the other hand, Chinese internet companies' core earnings have stabilized thanks to anti-hyper-competition policies, and substantive progress has already been made in AI productization and commercialization, improving from the Q2 situation of "continued core earnings downgrades + AI investment eroding profits with little return;" additionally, domestic substitution in computing hardware will also help with a revaluation of China tech assets overall.

Risk disclosure and disclaimerThe market involves risks and investment requires caution. This article does not constitute individual investment advice, nor does it take into account any specific investment objectives, financial circumstances, or needs of any particular user. Users should consider whether any opinions, views, or conclusions in this article are appropriate for their own circumstances. Investing accordingly is at your own risk. ```