In recent weeks, the Hong Kong stock market has been abuzz with questions regarding the sustainability of the Hang Seng Tech Index's upward trajectory. Following an impressive surge, investors are left pondering whether the index is still a viable investment or if it will, inevitably, follow historical trends of strong gains dissipating into corrective declines.
The spike in Hong Kong stocks can be directly attributed to significant investments in artificial intelligence (AI) by major players in the tech industry, particularly driven by firms like ByteDance, which has prompted other giants such as Alibaba and Tencent to jump on the AI bandwagon. Even amid a shaky economic climate where tech valuations have been scrutinized, internet companies remain some of the most promising candidates for AI monetization. Historical stock buybacks have lent additional support to share prices, despite market apprehensions. The recent launch of DeepSeek R1 in January has further reinforced the narrative surrounding the monetization of AI applications.
So, who is really driving this surge? To assess whether we could experience a rollback akin to September 24 of last year, it is essential to identify the primary buyers in this market and their ongoing commitment to investing. Events from the previous day present an informative case study. U.S. markets witnessed significant declines concerning KWEB (an ETF tracking Chinese internet firms) due to fears surrounding an "America First" investment memo, which suggested potential restrictions on U.S.-based pension funds investing in Chinese stocks. Typically, such narratives lead to steep sell-offs, and with accumulated gains in internet stocks, a period of profit-taking seemed likely, suggesting a potential downturn for Hong Kong stocks.
However, contrary to expectations, yesterday's performance of Hong Kong stocks exceeded projections. While many anticipated that the indices would follow suit, they instead exhibited resilience, sowing hope that traders on U.S. markets, specifically concerning ADR (American Depositary Receipts), would reflect this stability. An illustrative example includes Alibaba, which saw a sharp drop of 10% on U.S. markets, yet rebounded in Hong Kong trading, starting at a 7% loss but gradually recovering to close up by 3%. This remarkable recovery also influenced U.S. ADRs of Alibaba, which climbed almost 4% during after-hours trading.
In examining the major players fueling this momentum, data highlights that Southbound funds (capital flowing from Mainland China into Hong Kong) are now leading market activity. To date, these funds have seen a net inflow of approximately HKD 240 billion this year alone, with projections suggesting a total inflow of HKD 807.8 billion in 2024. This influx represents a quarter of last year's total, underscoring the heightened interest and optimism among investors.
A particularly telling observation from the previous day is that Southbound investments concretely bolstered Hong Kong markets, driving a net inflow of HKD 22 billion during trading. This capital was highly concentrated in the opening hours, utilizing around HKD 7 billion within the first hour of trading, showing that Southbound funds constituted nearly half of the market's total transaction volume. What’s more, traders have noted a shift toward more localized pricing dynamics, diverging from the traditionally strong correlation with ADR movements. This shift implies that local fundamentals are now having a material impact on valuations, and the recovery can be attributed to improving perspectives on the underlying companies rather than mere market sentiment.
As we pivot to the rationale behind the consistent flow of Southbound investments, it’s evident that the primary drivers include recalibrating the valuations of leading internet firms. The necessity of reassessing valuations stems from the premise that these companies are currently undervalued, while also indicating promising and verifiable growth avenues ahead. For internet giants like Tencent and Alibaba, the outlook is especially optimistic due to significant stock repurchase programs supporting prices. Tencent, in particular, demonstrates a high certainty of growth; likewise, Alibaba is transitioning from a defensive stock to a prominent figure that could benefit significantly from AI developments, showcasing potential income avenues that adhere to the increasing domestic demand for AI applications.
The appeal of AI adoption is twofold for these firms. First, they are focusing on enhancing operational efficiency through cost reduction. The integration of AI into their existing ecosystems promises advancements in advertising efficacy, mobile applications, and operational frameworks. For instance, improvements in performance metrics of Alibaba's proprietary search tools and Tencent's various applications may mirror the gains seen with similar technologies, although Tencent and Alibaba boast larger footholds in China compared to their Western counterparts like Meta.
Secondly, there are tangible opportunities in reevaluating the efficacy of their cloud services. Both Alibaba Cloud and Tencent Cloud have seen diminished focus since 2020, primarily due to a lack of demand. In stark contrast, American cloud service providers are continuously ramping up their investments, seeing high valuations. For example, a large portion of AWS's valuation stems from cloud operations, while Alibaba Cloud's market cap reflects less than 30% of its potential, and Tencent Cloud barely registers at 10%.
In light of these dynamics, the renewed focus on cloud services has created fertile ground for robust income growth within these firms. Accordingly, the players highlighted within the Hang Seng Tech Index that stand poised to benefit from AI applications include not only the aforementioned tech titans but also hardware innovators like Xiaomi, domestic chipmaker SMIC, and robotics enterprises.
As Tencent and Alibaba elevate their stories with a comprehensive narrative surrounding AI, the valuations that previously remained stagnant stand to gain significantly—from 15x PE ratios for Tencent possibly climbing to 20x, and Alibaba potentially doubling its valuation from 10x to 20x. This evolution underscores the anticipation of a gradual valuation acknowledgment through continued growth.
The allure for Southbound capital also rests upon the opportunities that the Hang Seng Tech Index offers for more localized AI investments. Above all, the variety of listed companies across both the A-share and H-share markets invites further interest; in cases like SMIC, the premium on its H-shares over A-shares has reached nearly 50%, providing a compelling purchasing advantage.
It is essential, however, to recognize that opportunities are not solely present on the Hong Kong side of the market. According to foreign investment commentary, A-shares hold strengths in AI hardware, while Hong Kong markets, buoyed by internet firms, offer superior prospects for successful AI application deployment.
As China and the United States accelerate their push into AI-related technologies, hardware manufacturers remain at the forefront of benefitting from increased CAPEX (capital expenditure) commitments from technology firms. The trajectory of revenue for hardware companies is contingent on these investments, with the interplay between U.S. and Chinese tech sectors fostering substantial demand for components and innovative solutions.
Illustratively, the surge in growth among North American cloud service providers like NVIDIA, Broadcom, and TSMC during 2023-2024 showcases a similar promise for domestic players in China, wherein investments from Tencent and Alibaba are expected to fuel developmental prospects for a suite of hardware vendors. Notably, in line with Alibaba's recent declarations, projections suggest an influx of no less than RMB 380 billion within the AI sector over the next three years, marking the beginning of a significant phase for domestic AI hardware investment.
Additionally, the Artificial Intelligence ETF (515070) emerges as an excellent avenue for exposure to both domestic AI hardware suppliers and those directly integrated within the NVIDIA supply chain, encompassed within China's immense growth potential and U.S. demand surge.
In summation, with major players like Alibaba and ByteDance committing nearly RMB 300 billion to AI-related ventures, the awareness of concrete demand seems to drive such expansive investments. This shift in corporate strategy reflects an evolving market narrative that promises both short-term gains and medium-to-long-term growth trajectories. As the market experiences periodic corrections, these represent prime entry points for investors aiming to capitalize on the leading firms well-positioned to reap the rewards. Engagement with the Hang Seng Tech Index ETF (513180) and the Artificial Intelligence ETF (515070) provides an effective means to participate in this overarching growth narrative centered around domestic AI applications and hardware capabilities.