During the National Day holiday, the A-share market was closed, while the Hong Kong stock market was actively traded from October 2nd to 4th, with trading volumes reaching a historical high, attracting the attention of global investors. The Hang Seng Index rose by 7.59% during this period, and the Hang Seng Technology Index increased by 10%. The "bull market flag bearer" securities stocks generally rose by 50% to 100% or even more.

After the recent consecutive surges, the Hong Kong stock market's performance for the year has ranked first among the world's major indices, leading the US and Japanese stocks. The latest EPFR data shows that following the inflow of passive (ETF) and transactional (hedge funds, etc.) funds in the previous week, overseas passive funds continued to flow in significantly during the National Day holiday, with a scale of 3 to 4 times that of the previous week.

According to the First Financial review of major international investment banks' research and statements during the National Day holiday, most institutions still believe that the market has considerable upside potential. Goldman Sachs has upgraded its allocation to China to overweight, raising the target price-to-earnings ratio of the MSCI China from 10.5 times to 12.0 times, which means there is further room for improvement compared to the current level of 11.3 times; information from Bank of America's trading desk shows that in the past two weeks, pure long positions have net bought $3.4 billion, similar to the amount bought during the rebound after the pandemic lockdown, but in a much shorter time. Global investors are trying to get ahead of the retail wave in the A-share market on Tuesday (October 8th) by buying Hong Kong stocks/ADRs (American Depositary Receipts) and any products with an A-share base. Therefore, institutions expect that any short-term decline may be shallow.

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However, the most attention from all sectors is still focused on the subsequent fiscal stimulus measures. The National Development and Reform Commission will hold a press conference on Tuesday to introduce the systematic implementation of a package of incremental policies, solidly promoting the economy to move upward in structure, and the development momentum to continue to improve.

International investment banks still have a bullish view on the Chinese stock market.

At present, although the scale of active foreign capital inflow is not large, it is also the first continuous net inflow for a longer period. Regionally, it is mainly dominated by China and Asian regional funds, while emerging market and global funds have not yet inflow. Some active funds, due to the market's continued surge, are forced to reduce underweight to prevent falling behind too much.

As of August, the benchmark for global active funds to allocate Chinese stocks was 5%, but it was underweighted by 1 percentage point. Research by CICC shows that if the allocation shifts from underweight to standard, it corresponds to nearly $40 billion in inflow, equivalent to the total outflow since March 2023.

Currently, major international investment banks are quite optimistic. Goldman Sachs believes that the Chinese stock market is expected to have a 15% to 20% upward space. There is not enough information to assert that a structural bull market has begun, as China's macro challenges remain significant (such as the real estate market, demographic structure, debt levels, weak domestic consumption, and geopolitical tensions), and the scale and specific measures of fiscal policy have not yet been announced. However, there are still ample reasons to believe that the stock market will continue to rise.

Firstly, valuations are still below the median level, with the current forward price-to-earnings ratio at 11.3 times, lower than the five-year average of 12.1 times, which had rebounded from a very low 8.4 times. If policymakers fulfill their commitment to support the economy, valuations may further recover. Empirically, there is a good correlation between fiscal easing and valuation expansion. At the same time, if policies can be transmitted to profit growth, profit improvement often helps valuation expansion.

Secondly, a lighter position itself is a form of reversal momentum. Hedge funds have quickly increased their exposure to China, but they are still at the 55th percentile of the five-year range, while they reached the 91st percentile at the peak of the rebound after the reopening following the pandemic in January 2023. At the end of August this year, public funds were underweight China by 310 basis points, and the market's sharp changes may have exacerbated this underweight. At the same time, mainland investors have also begun to increase margin financing from lower levels, similar to the rise in risk appetite when policy support was in place in 2015.From a broader perspective, the Japanese stock market has experienced seven rebounds ranging from 50% to 140% during the nearly 30-year bear market, indicating that attractive investment opportunities can exist even in challenging macroeconomic contexts.

Information from Bank of America's trading desk reveals that over the past two weeks, net long positions have increased by $3.4 billion, similar to the amount bought during the rebound following the pandemic lockdowns, but in a much shorter time frame. Global investors are trying to purchase Hong Kong stocks/ADRs and any products with a base in A-shares (ASHR).

Relatively speaking, the institution is more bullish on A-shares, as the momentum-driven rebound in Hong Kong stocks could potentially exceed expectations, but the risk-reward is not particularly attractive at present. The forward price-to-earnings ratio of the Hang Seng Index is now close to 10 times, near the reopening level (11 times). Historically, when valuations exceed this threshold, the returns of the Hang Seng Index (3-month forward) exhibit negative skewness. In contrast, the valuation of A-shares may be revalued more than H-shares. Although overseas holdings in A-shares have increased rapidly, domestic retail investors are just beginning to enter the market. On September 30, the percentage of margin trading volume to total trading volume rose above 10%, but it is still much lower than in 2014 (18%).

"In the two years leading up to the 2014 bull market, household bank deposits increased by 15 trillion yuan. On the eve of this rebound, bank deposits increased by 40 trillion yuan, with more funds available outside the market," the institution stated.

Be vigilant against "bubbles"?

Looking back at 2015, the market reversal was due to policymakers pressuring brokers to raise margin requirements and tighten collateral rules for obtaining these loans. Currently, investors are also on alert for potential warning measures.

"But this is a gradual process. The largest single stock position of Central Huijin is in state-owned banks and the CSI 300 ETF. Holding more small-cap A-shares than large-cap stocks would be a more favorable position layout. During the rebound on September 30, the inflow of funds into onshore ETFs was highly biased towards the CSI 1000 and CSI 500," Bank of America said.

First Financial Daily also learned from several brokerage branches that A-share trading has been hot recently, with investors showing great enthusiasm for opening accounts. Many brokerages have set targets for new account openings of around 50,000, and a surge in brokerage account openings has become a common phenomenon. Data shows that the majority of new account investors are young people, with those born in the 1980s and 1990s being the main force, and the number of accounts opened by those born in the 2000s has significantly increased. According to current rules, customers who open accounts during the National Day holiday can only start trading on October 9, so the actual impact will only be reflected on that day.

Nomura has recently begun to warn of risks. "Domestic and foreign Chinese stocks are soaring, and retail investors, especially young people who have not experienced previous bull and bear cycles, are eager to open accounts, fearing they will miss out on what seems to be a once-in-a-lifetime upward trend... The possibility of repeating the epic volatility of 2015 is rapidly increasing in the coming weeks," Nomura's Chief Economist for China mentioned in an email to reporters.

"Although the stock market does not seem to have reached that point yet, the macroeconomy remains fragile. The central government will definitely introduce a series of fiscal measures and other supportive policies, but there may still be uncertainty about the scale and content of the final fiscal plan," Nomura said.Lu Ting, Chief Economist of China at Nomura Securities, believes that under a more favorable scenario, officials are closely monitoring and will take timely measures to calm the frenzied stock market. The regulatory authorities will prudently control the scale and pace of fiscal stimulus, while turning their attention to difficult tasks including clearing up issues in the real estate industry and restructuring the financial system. Under the baseline scenario, a small-scale "bubble" and crash may be observed.

Focusing on the Scale and Direction of Fiscal Stimulus Policies

However, the current market's focus is not on being vigilant about bubbles; the carnival seems to still be in its early stages, with China's fiscal stimulus policies being the center of attention.

Morgan Stanley stated that if the Chinese government announces more spending measures in the coming weeks, the stock market could rise by another 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 while, with the last occurrence being after the beginning of last year. At that time, investors gave the MSCI China Index an expected price-to-earnings ratio of around 12 times.

Nomura believes that Beijing's stimulus spending may focus on four areas. First, to cope with the second wave of impact, the central government will increase fiscal transfers to local governments; second, the central government may accelerate the construction of large cross-regional projects to boost investment demand; third, the central government may consider increasing spending on social security for vulnerable groups; and finally, the central government may ultimately be forced to act as the "last builder," directly funding residential projects that have been pre-sold but delayed. However, the scale and pace of these efforts 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.

October 8th. The press conference of the National Development and Reform Commission (NDRC) may provide clues. This is another press conference on the systematic implementation of a package of incremental policies following the September 26th Politburo meeting. Huatai Securities believes that at present, stabilizing the economy is the key to stabilizing asset prices and expectations. From this perspective, as the leading department in stabilizing the economy, the NDRC is expected to provide more new directions.

For example, in terms of stabilizing investment, where is the increase in investment? Are there any policy guidelines for issuing government bonds or special government bonds? In terms of stabilizing the confidence of the private sector, how to help repair the balance sheets of the household sector and "promote income growth for low and middle-income groups"? In terms of providing a safety net for people's livelihoods and social security, how to act?

At the same time, the follow-up fiscal incremental policies are key, and the market is closely watching the Standing Committee of the National People's Congress (NPC) Chairman's meeting in early October and the NPC meeting in the latter half of October. Currently, market expectations are running too fast, with expectations for the scale of stimulus having risen from 2 trillion yuan to 5 trillion yuan and even 10 trillion yuan. Institutions believe that understanding "ensuring necessary fiscal expenditure" is key, and if a 2 trillion yuan incremental policy is announced, it would be in line with expectations, while 3 trillion to 5 trillion yuan would be beyond expectations.