CICC: Who is the “smart money”?

The Zhitong Finance App learned that CICC released a research report saying that Hong Kong stocks are currently more suitable to focus on market conditions and structural opportunities. The bank maintains the judgment of the Hang Seng Index of 26,000-27000 in the benchmark situation. Operationally, 1) if Hong Kong stocks rise to a close position, when combined with an accelerated return of active foreign capital compared to the previous trend, and southbound inflows slow down, profits can be realized appropriately; 2) if subsequent adjustments are made and southbound capital inflows again at an accelerated pace compared to the previous trend, the allocation can be increased again. In terms of direction, technology depends on industry, cycle depends on the Federal Reserve, and consumption depends on policy. If technological progress is limited in the short term, dividends can be used to moderately hedge portfolio fluctuations.

CICC's main views are as follows:

Since 2026, the performance of Hong Kong stocks and surrounding markets, including A shares, has continued to be misaligned, showing a typical “seesaw” effect. When the Korean stock and A-share technology sectors continued to strengthen in the first half of the year, Hong Kong stocks lost and capital flowed out. After the technology stock pullback in late June, Hong Kong stocks were able to rebound and capital flowed in. A similar phenomenon is not unique to this year; the same was true in 2025 or even earlier: Internally, the strong popularity of Hong Kong stocks in the first half of 2025 was accompanied by continued southward inflows, and southward inflows slowed after A-shares strengthened in the second half of the year; externally, overseas capital will also adjust the allocation of Hong Kong stocks as the attractiveness of stock markets such as Japan, India, and South Korea changes.

The reason for this phenomenon boils down to the fact that Hong Kong stocks are an “offshore market”. The lack of local capital makes it necessary to “compete” for the “attention” of different investors from other markets. The reallocation of different funds between markets will show a “seesaw” effect, and the low trading activity of Hong Kong stocks themselves will also amplify the impact of capital changes, further highlighting the importance of different capital behaviors.

Reviewing the relationship between southbound and overseas capital trends and market performance since 2016, the bank found the following conclusions: 1) Southbound capital inflows and outflows are related to strong market strength, but they also show certain “smart money” characteristics, such as slowing inflows after Hong Kong stocks have risen a lot, and speeding up purchases after Hong Kong stocks fall or lose out of A-shares. Compared with insurance capital, active public funding and ETF market follow-up characteristics are more obvious; 2) active foreign capital usually accelerates inflows only after performance and profit expectations improve, which is a lagging indicator; passive foreign capital is small in scale and is more affected by redemptions in non-Chinese markets, and the reference value of capital is greater; 3) When China's credit cycle fluctuates or overseas liquidity is tightened, the reference value of capital is greater: at this time, the accelerated inflow of active foreign capital means that the market rebound is imminent; the accelerated inflow of active foreign capital corresponds to subsequent earnings weakening. The opposite is also true. The southbound flow rate may have clearly slowed down or the outflow rate peaked out of the corresponding market. The accelerated outflow of active foreign capital mostly reflects the market's previous weakness.

Behavioral characteristics of different funds in Hong Kong stocks: Southbound has the characteristics of “smart money”. Active foreign investment is a lagging indicator, and passive foreign investment has little reference value

In the past ten years, although both south-bound and overseas passive capital had structured long-term inflows, the bank found that short-term capital changes were more important in terms of short-term market pricing. Therefore, the bank looks at the two dimensions of “change in capital flow rate” and “change in relative earnings”: “change in flow rate” is defined as the difference between the average daily net inflow for the past 1 month and the average daily net inflow for the past 3 months; “change in earnings” uses changes in the performance of the Hang Seng Index compared to other market indices over the past month.

First, in terms of overall trends, southbound capital is highly correlated with market performance. Second, in terms of marginal changes, southbound capital inflows often slow down after a sharp rise. After Hong Kong stocks fall or lose out of A-shares, they buy faster, and show certain characteristics of “smart money.” Looking further, when the southbound inflow rate was at the top 20% in history, the Hang Seng Index rose by an average of 1.7% over the next 20 trading days; after the southbound inflow changed from acceleration to slowdown, the Hang Seng Index usually weakened after 3-5 trading days, then fell by an average of 1.6% over the next 20 trading days. This shows the ability to increase positions at a certain low level and take profit at a high level, so it has the characteristic of “smart money.”

Looking at different types of investors: Insurance capital is the main long-term buying power from the south. It also increases allocations when Hong Kong stocks fall sharply and decreases holdings when they rise a lot. Dividend probability is the main direction of allocation. Active public offerings and ETFs follow the market more, accelerating inflows when they rise and switching to outflows when they fall.

Active foreign investment is a lagging indicator of the market and profit, with a lag of one to two quarters. Because passive foreign investment is small and not necessarily allocated to China, the signal is less meaningful. Since mid-2020, passive foreign capital has continued to flow into Hong Kong stocks, with a cumulative inflow of about US$120 billion, but this has not changed the three-year fluctuating decline of Hong Kong stocks from 2021 to 2024. The reason is that changes in passive capital are mainly affected by the scale of passive investment around the world. Instead of capital flows specifically to Hong Kong stocks, it first flows into emerging market index products, and then is naturally allocated to Hong Kong stocks according to index weight. Therefore, the indicative significance of passive foreign investment on short-term market trends is relatively limited.

How to use funding signals? The value is greater when China's credit cycle shocks and overseas liquidity is tight

So, combined with the behavioral characteristics of different types of funds, how can we make better use of capital signals to judge market trends?

Although Hong Kong stocks, as an offshore market, are more sensitive to changes in capital, after all, capital is only one of the dimensions affecting market trends, not to mention that other factors themselves also influence capital trends. As a result, the bank found that when fundamental trends are unclear and peripheral liquidity is not in a favorable environment (as is currently the case), the impact of capital is greater; conversely, capital may not dominate. Specifically,

First, when China's credit cycle clearly expands or contracts, the direction of fundamentals is clear, and the reference value of capital changes falls at this time. The southbound flow rate is close to zero during the credit expansion and contraction phase, and the correlation coefficient with Hang Seng Index earnings for the next 3 months is close to zero. The correlation coefficient between the scale of active foreign capital inflows and future Hang Seng Index earnings during the credit expansion and contraction phase is close to zero. Historically, China's credit cycle continued to expand in the second half of 2020. Although southbound inflows slowed at different stages, Hong Kong stocks continued to rise; the 2021 credit cycle contracted, and the Hang Seng Index was still under pressure even though overseas liquidity was relaxed and southbound inflows accelerated for a while; and the credit pulse rebounded after “924” in 2024, and capital and markets maintained inflows and increases for a long time, all indicating that when the direction of the credit cycle is clear, capital reference value is limited.

In the volatile phase of the credit cycle, capital signals are even more significant: an accelerated southward inflow means that the market may bottom out; an accelerated inflow of active foreign capital may instead mean that Hong Kong stocks may fail. The broad fiscal deficit pulse and private social finance pulse are repeated. Fundamentals lack a clear direction and when the index fluctuates, the bank estimates: 1) The correlation coefficient between changes in the southbound capital flow rate and the past earnings of the Hang Seng Index is about -0.1, and the correlation coefficient with future earnings is 0.2, which means that the southbound trend tends to accelerate inflows at a low level of the market, and vice versa. 2) The correlation coefficient between the scale of active foreign capital inflows and the Hang Seng Index's earnings in the past 1-3 months was as high as 0.4-0.6, and the correlation with the future earnings of the Hang Seng Index changed to about -0.3, indicating that the lagging characteristics of active foreign capital were obvious at this stage. The market had performed well enough before, and active foreign capital flow only improved, but the market had also been running for some time, and vice versa. For example, in 4Q22, the credit cycle fluctuated, and the southbound inflow accelerated before the phased bottoming out of Hong Kong stocks. During the same period, active foreign capital continued to sell in line with previous weakness, and then Hong Kong stocks rebounded.

Second, when overseas liquidity is tightened, capital signals have more reference value. For example, during the Federal Reserve's interest rate hike phase, Hong Kong stocks may weaken after active foreign capital inflows accelerate, and the southbound acceleration of purchases of corresponding Hong Kong stocks bottomed out. Conversely, after liquidity loosened, both types of rules weakened markedly. 1) Active foreign investment: During the Fed's interest rate hike phase, the correlation coefficient between the scale of active foreign capital inflows and Hang Seng Index earnings for the next month is -0.3, indicating that earnings weaken after the acceleration of active foreign capital inflows, while the correlation narrows to close to zero during the interest rate cut phase. 2) Southbound capital: Affected by the linked exchange rate system and the higher holdings of overseas investors, the discount price of Hong Kong stocks is more likely to expand than A shares during the Fed's interest rate hike. The correlation coefficient between southbound capital flow and accelerated sales at high levels is also more obvious. The correlation coefficient between southbound capital flow and Hang Seng Index earnings for the past 1-3 months is about -0.5, and the relative return for the next 3 months is 0.3, indicating that southbound inflows usually accelerate after the market weakens, and vice versa.

Implications for allocation: The current capital signal is more important. Southbound inflows are slowing down and active foreign capital inflows are accelerating, which means it is still a structural opportunity

Currently, China's credit cycle is fluctuating and weakening, and restrictions on overseas liquidity are rising, so capital signals are more worthy of attention.

China's credit cycle is still in a phase of total fluctuation and structural differentiation, and the broad fiscal deficit pulse may be slightly repaired in the third quarter. The private social finance pulse increased slightly in July, and the credit pulse differentiation between enterprises and residents narrowed slightly, but the broad fiscal deficit pulse weakened further. Looking ahead, the bank estimates that the broad fiscal deficit pulse or upward recovery in the third quarter was mainly due to the slow pace of fiscal financing in January-July, with a year-on-year decrease of 1.1 trillion yuan, reserving room for strength later. However, total fiscal growth for the whole year was limited, and the investment direction was still biased towards technological and industrial upgrading, so it could lead to phased recovery, but it was difficult to fully expand the credit cycle.

Overseas liquidity is still limited, and expectations of interest rate hikes are heating up after the Jackson Hole meeting. Walsh stressed that the current economy and employment are still resilient, and financial conditions are difficult to say tight. Only confirming that inflation is clearly returning to the 2% target will mean that no further action is needed, or that it will be difficult for the Fed to clearly shift to easing in the short term. The probability that CME interest rate futures are included in the Fed's September rate hike is 60.2%, so there is limited room to simply rely on improved overseas liquidity to drive the expansion of Hong Kong stock valuations in the short term.

In this environment, the importance of capital trends is even more prominent. Southbound capital inflows have slowed in the past month, and active foreign capital inflows have accelerated. This means that the possibility that the market will usher in greater opportunities in the short term is limited, and may even weaken. This is also in line with recent market performance.

Therefore, Hong Kong stocks are currently more suitable to focus on market trends and structural opportunities. The bank maintains the judgment of the Hang Seng Index at 26,000-27000 in the benchmark situation. The trend since this year is also basically in line with its judgment. For example, at the end of last year, the market generally saw 30,000 points or higher. The bank indicated that Hong Kong stocks showed bottom characteristics in early July and insufficient momentum in early August. In summary, there is still an “odds” mentality in the short term. To get out of a sustainable market in the medium to long term, we still need to see a recovery in residents' credit cycles or a breakthrough in leading Internet industries, that is, “924 hours” or “DeepSeek moments” are needed. Operationally, 1) if Hong Kong stocks rise to a close position, when combined with an accelerated return of active foreign capital compared to the previous trend, and southbound inflows slow down, profits can be realized appropriately; 2) if subsequent adjustments are made and southbound capital inflows again at an accelerated pace compared to the previous trend, the allocation can be increased again.

In terms of direction, technology depends on industry, cycle depends on the Federal Reserve, and consumption depends on policy. If technological progress is limited in the short term, dividends can be used to moderately hedge portfolio fluctuations. The bank's own AI pressure index has clearly declined from the previous extreme level. The stage of maximum pressure has gradually passed, and the pressure on industry fundamentals has been further mitigated, but further progress still requires new catalysts to open up the “ceiling” of current demand. Technology can still be used as the main direction of allocation. In addition to technology, it can be moderately balanced in the cyclical direction in terms of position concentration. Conversely, consumption may have to wait for fiscal policy progress in the fourth quarter. The bank's own cross-market and cross-industry winning odds framework shows that the overall odds score for insurance, transportation, raw materials, energy, and semiconductors for the week of September 4 was high.