CITIC Securities: The liquidity of Hong Kong stocks continues to improve. If there are fluctuations in line with overseas markets, it would be a good opportunity to increase positions.

CITIC Securities' research report noted that before the potential entry point for an index bull market from late Q3 to Q4, we will experience a 3-4 month transition phase. This report focuses on analyzing the environment and coping strategies during this period. Macro front, domestic demand and price signals remain weak, requiring more concrete measures to curb cut-throat competition and stimulate domestic demand. Overseas uncertainties persist, with the potential passage of the US tax cut bill possibly triggering another round of market turbulence. Market-wise, A-share small-cap stocks and thematic sectors are generally at elevated levels, and after extreme performances from April to May, volatility may emerge. For coping strategies, resisting macro disturbances relies on high-growth industrial trends like AI, where recent positive developments in North America's AI application sector will soon be mirrored in the Chinese market. Cross-market balanced allocation is another approach, as Hong Kong stocks' liquidity continues improving, making potential volatility-driven pullbacks good opportunities for position building.

The full report follows:

Domestic Demand and Price Signals Remain Weak, More Concrete Anti-Competition and Demand Stimulus Measures Needed

After the Sino-US trade tensions stabilized following leaders' calls, with external circulation pressures temporarily easing, internal circulation bottlenecks will regain market focus as the pricing center. Typical price indicators show: average listing prices for second-hand homes in tier-1 cities continued their pullback with declining transaction volumes; May saw across-the-board price cuts by representative brands in dining, fast food, and coffee sectors; during the Dragon Boat Festival, domestic economy-class airfares dropped 0.7% YoY, still 11% below 2019 levels; May's manufacturing PMI components for raw material purchase prices and ex-factory prices both declined further, with the latter approaching August 2022 lows. Industry-specific manifestations include proactive car price cuts for destocking, reduced home appliance subsidies, intensified e-commerce subsidy competition, and frequent state media commentaries against "cut-throat competition," indicating gaps in meeting this year's government work report targets for comprehensive rectification. As a key anti-competition measure, the State Council's revised Regulations on Guaranteeing Payments to Small and Medium-Sized Enterprises took effect June 1, mandating 60-day payment terms for government procurement contracts while prohibiting compulsory non-cash settlements like commercial bills, with established protection mechanisms. Implementation progress warrants close monitoring.

Overseas uncertainties remain significant, and the implementation of the tax cut bill could potentially trigger a new round of overseas turmoil.

In the short term, the core operating metrics of leading US companies in 1Q25 remain robust, with 38% of the sample companies we track showing acceleration in their core operating metrics. However, if the tax cut bill proposed by the Trump administration is implemented, particularly Clause 899 ("Enforcement Measures Against Unfair Foreign Taxes"), it could exacerbate market concerns about the creditworthiness of the US dollar. Despite the continued strength of the US stock market, the scenario of a strong US stock market and a weak US bond market has begun to affect the overall portfolio returns for large global asset management firms. If the S&P 500 and the long-term US Treasury price index (using the iShares 20+ Year Treasury Bond ETF) are weighted at 6:4, the cumulative decline in the portfolio since December last year has reached -3.3%. During the same period, if the MSCI China Index and the CSI Government Bond Index (denominated in US dollars) are weighted at 6:4, the cumulative return rate has reached +11.3%. In other words, the overall US dollar return rate for investing in Chinese assets (including stocks and bonds) has significantly outperformed that of US dollar assets. This year, many US pension funds are facing asset allocation reviews, and it is a general trend to gradually reduce reliance on US dollar assets and seek diversified investment strategies. Europe may be the first stop for long-term capital to increase its holdings, followed by the Asia-Pacific region.

A-share small-cap and micro-cap stocks and thematic investments are generally at high levels, and fluctuations may occur after the extreme performance in April-May.

Currently, the trading congestion and valuation divergence of small-cap stocks relative to large-cap stocks are both at high levels. The ratio of trading volume between the CSI 1000, CSI 2000, and the CSI 300 (MA5) stands at the 96.6% and 98.5% percentile levels since 2021, and at the 85.9% and 99.3% percentile levels since 2015, respectively. According to survey data from CITIC Securities' channels, the position levels of sample active private equity funds over the past four periods (from the week of May 8 to the week of May 30) were 77.3%, 77.6%, 79.8%, and 77.9%, respectively, indicating some position increases during the rotation of small-cap and thematic stocks. During the extreme performance of small-cap and micro-cap stocks and thematic rotations in April-May, the profit-making effect gradually diminished. The trading loss indicator we constructed was at the 31.5% percentile level since 2015 as of June 6, continuing to pull back from the 87% percentile level at the end of April and the 41% percentile level in mid-May.

To withstand macro disturbances, we still need to rely on industrial trends like AI. New changes are occurring in North America, and China will follow suit.

Against the backdrop of rapid improvements in model long-text and memory capabilities, C-end applications are evolving towards personalization, with user experience and engagement continuously improving, driving a surge in inference demand. The daily average token call volumes of clients such as Microsoft and Google have reached the trillion-level, far exceeding the load levels of the traditional chatbot era. According to consensus estimates from Visible Alpha, from 1Q25 to 4Q26, the ratio of NVIDIA + AMD's GPU revenue to Broadcom + Marvell's ASIC revenue is expected to decline from 7.4x to 5.7x. Leading US AI chain companies reported strong 1Q25 results, with CSP, applications, computing power, servers, supply chain, and energy sectors generally exceeding expectations, driving an upward revision in investor expectations. During the same period, the performance of A-share-related AI sectors significantly lagged behind, possibly due to domestic macro narratives and the focus on pharmaceuticals and consumption over the past two months. The valuation levels of core companies in the North American AI supply chain are very reasonable. As long as the expectation of a slowdown in computing power utilization is reversed, the current positions still offer good value. Most A-share companies in the North American AI chain have reported negative returns since the beginning of the year, with many valuations falling to lower percentiles over the past six months. The PE/PB percentiles of sectors such as AI chips and optical modules are generally below 50%, making them the best direction to withstand market volatility and macro instability during the semi-annual reporting season. The domestic chain may lag slightly behind the North American pace, but referencing the progress of DeepSeek, this time difference may only be 3-6 months. Starting in Q3, it is expected that there will be a new round of catalysts for domestic applications and domestic computing power. First, we may see domestic internet giants increasing their investment in personalized AI (long text + memory), and the launch of DeepSeek's new model may also bring new changes.

The liquidity of Hong Kong stocks continues to improve, and if there is volatility overseas, it would be a good opportunity to increase positions.

The current trading volume of Hong Kong stocks remains relatively active, with the valuations of core internet leaders still in the upper-middle range of the normal valuation interval. The asset quality of Hong Kong stocks is also systematically improving. In addition to the existing exclusive new economy leader assets, the listing of A-share companies in Hong Kong has brought a large number of high-quality manufacturing leader companies. The 18C regime is more attractive to specialized and innovative enterprises, and US-listed Chinese stocks are also expected to accelerate their return. Furthermore, the Hong Kong stock market has actually taken the lead in accumulating the first wave of profit effects since last year. According to China Securities Journal, data from third-party institutions show that the average yield of private equity subjective long-only stock strategy products in the first five months of this year was 6.84%, with 1,189 products achieving positive returns, accounting for 68.65%. As of June 6, the average yield of public active equity products was 2.42%. The performance of subjective long-only private equity significantly outperformed the overall public equity market, possibly precisely because private equity funds have a higher allocation weight in Hong Kong stocks (according to survey data from CITIC Securities channels, sample private equity funds had approximately 50% of their positions allocated to Hong Kong stocks in late March), while public funds still face relatively more restrictions and obstacles in allocating to Hong Kong stocks. Against the backdrop of a generally positive long-term trend for Chinese assets, the bull market in Hong Kong stocks continues. Any adjustments due to overseas market volatility would present a good opportunity to increase positions.

Avoid macro fluctuations, return to industry trends, and balance the allocation between Hong Kong and A-shares

1) The market is currently entering a phase where macroeconomic disturbances are gradually diminishing. It is important to ignore the noise and return to industry trends. The market's main focus will gradually shift from macro-level disruptions to the verification of fundamentals and the effectiveness of policy implementation. Currently, domestic demand and price signals remain weak, and policies aimed at combating cut-throat competition and boosting domestic demand still need to be strengthened. Overseas uncertainties persist, with the US's "Inflation Reduction Act (IRA)" and its implementation details, particularly those involving taxation of foreign enterprises, potentially becoming triggers for a new round of volatility. In this market context, we recommend placing greater emphasis on fundamental investment logic during the semi-annual report season from June to August, avoiding excessive reactions or trading based on frequent macroeconomic information.

2) For A-shares, focus on the AI chain, while Hong Kong stocks enter a phase of bottom-up stock selection. The widespread adoption of long-text and memory functions is driving continuous growth in AI inference demand in North America, representing the industry trend most likely to continue exceeding expectations in H2. In the AI sector, the first clear opportunities lie in reasonably valued and undervalued hardware companies related to the North American AI supply chain. As domestic AI applications gradually catch up, there is also room for growth in the domestic chain by 3Q25. In terms of specific allocations, the main areas with clear growth trends and relative independence from macro factors are AI and innovative pharmaceuticals. Given the previous over-concentration in innovative pharmaceuticals, we recommend a return to the AI chain from June to August. The computing power supply chain (AI servers, ASIC chips, optical modules, switches, etc.) warrants close attention, while the application segment requires continuous tracking and observation. Additionally, liquidity in Hong Kong stocks continues to improve, with core large-cap stocks trading at the mid-to-upper end of their valuation ranges. Even if there is insufficient short-term upward beta elasticity, there is still significant room for bottom-up stock selection with a high tolerance for error. We recommend continuing to balance the allocation between Hong Kong and A-shares.

Risk Factors

Intensified friction in the technology, trade, and financial sectors between China and the US; unexpectedly tightened macro liquidity both domestically and overseas; further escalation of conflicts in Russia-Ukraine and the Middle East; slower-than-expected digestion of China's real estate inventory; and unexpectedly prioritized policies under Trump.