Since the start of 2026, the Hong Kong stock market has underperformed, with the Hang Seng Tech Index, often regarded as a "core asset," lagging significantly. While the Hang Seng Index and the Shanghai Composite Index appear similar in performance, broad market indices mask considerable structural divergence. For instance, A-shares experienced a strong start post-New Year with 17 consecutive gains, whereas Hong Kong stocks notably trailed behind, especially compared to robust growth sectors. The recent correction in Hong Kong equities reflects a combination of weak fundamentals, concerns over tightening liquidity, and diminishing appeal of the market's unique structural characteristics. Amid a volatile or even weakening credit cycle, the upside for major indices remains limited, with the Hang Seng Index expected to hover around the 28,000–29,000 range. Opportunities are likely to arise from sector-specific strength or unexpected index pullbacks, making the recent weakness in Hong Kong stocks understandable.
Looking ahead, the market outlook will depend on three key factors: the credit cycle determining index performance, industrial trends dictating sector strength, and liquidity amplifying volatility. In terms of allocation, the overarching strategy remains aligned with credit expansion, prioritizing AI technology and cyclical sectors, which are the primary drivers of current credit growth. However, even with a clear direction, market fluctuations may occur due to sentiment-driven capital flows. In the near term, based on sector rotation scoring models, investors may consider focusing on essential retail, technology hardware, and new consumer sectors.
Key observations include: - Since the beginning of 2026, Hong Kong stocks have underperformed, with the Hang Seng Tech Index ranking among the worst performers globally. - Although the Hang Seng Index and Shanghai Composite appear comparable, structural disparities are significant. For example, A-shares rallied strongly after the New Year, while Hong Kong stocks lagged. - In mid-January, as A-shares cooled, southbound capital shifted attention to Hong Kong stocks, driven by catalysts in new consumer sectors, non-ferrous metals, and internet companies. However, subsequent global precious metal volatility, concerns over the Federal Reserve's hawkish stance, and headwinds for U.S.-China tech giants exerted triple pressure on Hong Kong stocks via risk appetite, liquidity, and structural factors. - Since February, the Hang Seng Index has declined by 3%, underperforming the Shanghai Composite and S&P 500, which fell by 1.3% and 0.1%, respectively. The Hang Seng Tech Index dropped 6.5%, hitting its lowest level since July of the previous year and retreating nearly 20% from its October peak.
Reasons for Hong Kong's underperformance include: - Liquidity tightening concerns: The nomination of a relatively hawkish Fed chair supportive of balance sheet reduction has raised fears of global liquidity contraction, negatively impacting liquidity-sensitive assets like the Hang Seng Tech Index, Nasdaq, and Bitcoin. - Reassessment of AI capital expenditure narratives: Recent volatility in precious metals dampened global risk appetite. Internally, market skepticism emerged regarding tech giants' AI spending, with concerns that excessive investments may strain cash flow and returns. Additionally, rumors about value-added tax adjustments for internet services and perceptions that holiday红包 campaigns were short-term KPIs rather than core AI initiatives further pressured sentiment. - Weak fundamentals: The relative performance of the Hang Seng Index versus the CSI 300 correlates with China's manufacturing PMI, which declined by 0.8 percentage points to 49.3 in January–February, below expectations. Policy support remains focused on structure and efficiency rather than broad stimulus, as seen in weaker year-on-year credit and fiscal data.
Outlook for Hong Kong stocks: - Credit cycle determines index upside: Amid weak private sector demand and high base effects, credit growth may continue to soften. If fiscal policy merely maintains 2025 levels, the broad fiscal deficit pulse will likely decline. Under a baseline scenario, the credit cycle may oscillate weakly, limiting index gains. Key policy directions from the upcoming National People's Congress will be crucial. - Industrial trends dictate sector strength: Hong Kong's unique sectors—dividend plays, technology, consumer, and cyclicals—rely heavily on tech (especially AI) and new consumer segments for valuation support. Despite recent debates on AI bubbles, long-term trends remain intact. If leading tech firms adopt sustainable investment strategies, upward potential may improve. - Liquidity amplifies short-term volatility: As an offshore market, Hong Kong is sensitive to external liquidity. Fed policy shifts, southbound capital fluctuations influenced by A-share performance, and active IPO pipelines (with over 400 companies in queue and significant lock-up expiries in H1 2026) may cause disruptions.
Short-term perspective: Market overreaction to Fed chair nominations, AI bubble concerns, and unverified tax rumors may have led to oversold conditions, creating potential for a rebound. Medium-term, under baseline assumptions, 3–4% earnings growth and sentiment recovery in key sectors could lift the Hang Seng Index to 28,000–29,000.
Comparing A-shares and Hong Kong stocks: - A-shares benefit from stronger fundamentals and liquidity, supported by tech hardware, manufacturing exports, rising PPI, and cyclical sectors. Estimated 2026 earnings growth of 4–5% slightly outpaces Hong Kong's 3–4%. - Hong Kong's advantage lies in its unique sectors—internet, innovative pharmaceuticals, new consumer, and high-dividend plays—which are scarcer in A-shares. If catalyzed, these could drive relative outperformance.
Sector allocation framework: - Credit cycle direction guides strategy: During credit contraction, fixed-income assets and dividends are favored; during broad recovery, cyclicals and consumption lead; in extreme inflation, gold becomes the hedge; during partial recovery, structural opportunities emerge. - Rotation is key: Even with clear trends, capital concentration can cause short-term imbalances. A dual approach—assessing fundamentals (earnings, valuation) and capital flows (southbound activity, crowding, short-selling, RSI)—helps identify timing.
Current allocation recommendations: - High priority: Essential retail, tech hardware, and new consumer sectors score well on both fundamentals and liquidity metrics, offering clear profit recovery without extreme valuations or overcrowding. - Watchlist: Financials, biotech, semiconductors, and non-ferrous metals show solid fundamentals but weaker short-term capital support, suitable for medium-term positioning rather than immediate bets. - Tactical opportunities: Real estate, energy, software services, and consumer durables may see sentiment-driven trades but lack sustained fundamental support. - Avoid: Sectors with weak fundamentals and poor liquidity, such as capital goods, auto parts, e-commerce, and household products, await catalysts.