On October 3rd (Thursday), the A-shares market continued to be closed for the holiday, while the Hong Kong stock market opened low and continued to decline, correcting after several days of consecutive increases. In the afternoon, the Hong Kong stocks rebounded sharply in a "deep V" pattern. By the close, the Hang Seng Index fell by 1.37% to 22,136, and the Hang Seng Technology Index fell by 3.3% to 4,986.87. Overseas institutions indicated that profit-taking and increased selling across various products.

On October 2nd, due to the A-shares holiday closure, many A-share investors turned to the more flexible Hong Kong stocks for trading. By the close of that day, the Hang Seng Index had risen by over 6%, and the Hang Seng Technology Index had risen by over 8%. The Hong Kong stock market even witnessed an epic scene — the Wind China Securities Broker Index surged by 35%, setting a new historical high, with CMBC Hong Kong rising by 206%, and China Merchants Securities rising by over 80%.

In the future, the situation in the Middle East and the U.S. non-farm employment data on Friday will continue to affect the market.

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Profit-taking and short-term selling increase

After the surge, the market on Thursday seemed to start returning to rationality. Information from the Goldman Sachs trading desk showed that for the first time since the rise in A-shares and Hong Kong stocks last week, there were signs of consolidation today. Observing the resilience of this rise and the strength of "buying on dips" will be very meaningful. So far, institutions have seen an increase in profit-taking and selling across various products:

Options: Closing in-the-money call options and call option spreads (only a small part of what was bought last week); Futures: For the first time since the rise began, investment banks have seen an increase in selling; Spot: Increased selling from long-term investors and hedge funds, with buy orders this morning being shelved, and long position sell orders shifting from outperforming the market to being in line with volatility (the opposite of the previous day's situation).

Since the end of August, the Hang Seng Technology Index has surged by nearly 44%, and it is not surprising to see consolidation. David Scutt, a senior strategist at嘉盛集团, told reporters that, in fact, copper and iron ore futures, which are closely related to China's recovery expectations, are still far below their highs at the beginning of this week, and the US dollar/CNH has rebounded back above 7.0000, which may be a warning signal that the stock index's optimistic sentiment has not continued to other markets. As of 16:50 Beijing time on October 3rd, the US dollar/CNH was reported at 7.0436.

In addition, he also mentioned that the Hang Seng Index has approached a resistance level. "How sudden the recent increase has been may reflect the impact of short covering and a large influx of capital. Looking up, the price encountered resistance at 22,795 on Tuesday morning, which is the double top formed in January 2023. If it breaks through that level, 24,900 will be the next target. Now the index is obviously suppressed by resistance, with support downward near 21,066, a level where the rise stalled last week and was also the support and resistance at the beginning of 2023."

Under the bull market driven by capital, the movement of funds is also key for the future. Considering that this rise was mainly driven by the reconfiguration of funds, here is a summary of the stock positions of mutual funds, hedge funds, retail investors, and southbound capital:

Goldman Sachs trading desk information shows that, in terms of long-term mutual fund positions (as of the end of August), before this rise, the exposure of Asian and global funds to China reached the lowest level in the past decade, and the cash levels of mutual funds were also near multi-year lows. These institutions generally act slowly and did not significantly increase their positions this time, which may mean that if the market continues to rise, funds from other markets may rotate into China."Over the past few days, we have observed long-term investors buying into high-quality Chinese popular stocks, but considering the gap in relative performance, actively managed index-tracking funds may have more buying demand to prevent underweight positions in the event of continued rallies," a U.S. investment bank trader told reporters.

According to rough estimates based on EPFR data, the surveyed global mutual funds (with an asset management scale of about $3 trillion) are overall underweight China by 3%, meaning long-term investors need to buy about $100 billion in A-shares, H-shares, and ADRs to restore a neutral allocation.

Looking at hedge fund positions (as of the end of September), net allocations have increased significantly over the past two weeks. The overall allocation reached 5.9% at the end of September (the 32nd percentile in five years), increasing by 1.2% this month; net allocations reached 9.2% (the 49th percentile in five years), increasing by 2.4%. During the previous rallies (China's reopening after the pandemic, the 2022 Politburo meeting), institutions observed an increase in net allocations by 3% to 6%, and overall allocations increased by 1.5% to 2.5%.

In terms of Southbound capital, since September, it has generally been in net inflow, and it has been net buying for 15 consecutive months (the last month of net selling was June 2023). So far this year, Southbound capital has been the largest buyer in Asia, with a net buying scale of $63 billion. The participation of Southbound capital in Hong Kong has steadily increased, and as of 2024, the proportion of Southbound capital inflows to Hong Kong's total turnover has reached a new high of 16%. Southbound capital will resume trading along with China's A-shares on October 8th (Tuesday).

The strength of fiscal stimulus determines the subsequent market direction.

Currently, there is indeed capital flowing out of the stock markets of India, South Korea, and Japan, and allocating to the lower-valued Chinese stock market. Compared to the Indian stock market's P/E ratio of nearly 25 times, MSCI China is only about 11 times, and during the peak trading period in previous years, the P/E ratio was only 18 times. At present, in addition to the cheap stock market valuations, China's fiscal stimulus policy is also anticipated.

"Indian valuations are indeed a bit too high, and the stock markets of Taiwan and South Korea are affected by the downturn in the semiconductor and technology cycle. The slowdown in the U.S. economy may also affect the U.S. and global stock markets," said Miao Zimei, Head of Equities for Greater China at Janus Henderson Investors, to First Financial Daily reporters. However, the market is also currently paying attention to subsequent policy measures, especially whether the strength of fiscal stimulus will meet expectations.

Morgan Stanley stated that if the Chinese government announces more spending measures in the coming weeks, the Chinese stock market could further rise by 10% to 15%. The expectation of further increasing fiscal expansion has returned to the table, allowing investors to view China from a reflation perspective for the first time in a long time, with the last time being after the beginning of last year. At that time, investors gave the MSCI China Index an expected P/E ratio of about 12 times.

According to the reporter's understanding, the major domestic and foreign investment banks' expectations for fiscal stimulus are that additional government bond issuance is expected to be approved in the fourth quarter, with fiscal expenditure possibly reaching 3 trillion yuan.

Lu Ting, Chief Economist of Nomura China, said in a report on October 3rd that for investors, after enjoying the initial revelry, it is particularly necessary to prepare for adverse scenarios. In a favorable scenario, policymakers will closely monitor the brewing bubbles and take timely measures to calm the frenzied stock market. At this time, the scale and pace of fiscal stimulus may be more cautious, while the government shifts its focus to more difficult tasks, including cleaning up the chaos in the real estate industry and restructuring the fiscal system; in the baseline scenario, a smaller bubble and potential bubble burst may be seen. In this case, policymakers may try to introduce fiscal measures to stabilize demand and maintain the basic operations of local governments, but may not be able to solve any serious structural problems.In the coming months, it should be closely monitored how the policy level navigates through uncharted waters. Lu Ting believes that "we think the policy will initially focus on three areas. First, to cope with the second round of shocks, the central government will increase fiscal transfers to local governments; second, the central government may accelerate the construction of major cross-regional projects to boost investment demand; third, the central government may consider increasing social security spending on impoverished groups." He believes that in the future, the central government may ultimately become the "last builder," directly funding residential projects that have been pre-sold but delayed in delivery. However, the scale and pace of policy may be more uncertain. The scale of incremental stimulus may ultimately be limited to 3% of GDP per year, and the market should pay more attention to the specific content of the stimulus measures.