Most of the Positives from the Hong Kong Equity Rally Are Priced In; Morgan Stanley Tactically Rotates into A-Shares

Overview

This report compares tactical opportunities in A-shares and Hong Kong equities. Morgan Stanley believes that many of the factors driving the rise in Hong Kong equities since July have largely been reflected in prices, and therefore investors should now take some profits and rotate into A-shares; a new allocation window for Hong Kong equities may emerge in late September amid changes in external volatility, policy, China-US relations, and artificial intelligence events.

Core views

The report first reviews the drivers of the recovery rally in Hong Kong equities since July and concludes that these factors are now largely priced in. Second-quarter results showed that the earnings downturn is beginning to bottom, with the internet and e-commerce sectors benefiting in particular from regulators' efforts to curb price competition since mid-April 2026. Major Chinese internet platforms also launched new large models and added artificial intelligence capabilities to their existing ecosystems, easing market concerns that their capital expenditure expansion would fail to generate returns. Meanwhile, the pressure from large-scale IPO share lockup expirations accumulated since May was gradually absorbed in July and August, financed short positions established in Hong Kong equities during the global market pullback were partially covered, and global investors had previously maintained very low exposure. Precisely because these positives have already driven a rebound, the report recommends temporarily taking profits from Hong Kong equities rather than continuing to chase the same thesis. By contrast, the report expects the A-share market environment to improve gradually from current levels. Stabilization in global markets and a recovery in the artificial intelligence supercycle should help A-share sectors with substantial exposure to semiconductors, deep technology, and advanced manufacturing move in tandem with the global technology cycle. Short-term liquidity pressure from large A-share IPOs such as ChangXin Memory Technologies and Unitree Robotics should also be gradually absorbed by the market. Historical data from five technology IPOs that raised more than RMB 10 billion show that during the second to fourth weeks after listing, the new stocks' average daily turnover as a share of total market turnover declined by an average of 0.5 percentage points from the first week, indicating that the impact mainly takes the form of temporary trading concentration and narrower market breadth. In addition, the national team resumed buying during the correction in the global artificial intelligence sector in July and may continue to act as a market stabilizer. The report is not bearish on Hong Kong equities over the long term. It believes that the next potential window for renewed momentum will emerge around late September. If global markets become volatile again due to concerns about fiscal sustainability, rising bond yields, renewed doubts about the global artificial intelligence investment cycle, or geopolitical uncertainty, the defensive characteristics of Hong Kong equities may regain attention. September also features multiple artificial intelligence catalysts, including Tencent's Global Digital Ecosystem Summit and WeChat artificial intelligence launch, Alibaba's Qwen 4.0 upgrade and Apsara Conference, Baidu's potential dual-primary listing and inclusion in Stock Connect, and new model releases from MiniMax and Z.AI. The report also monitors whether President Xi Jinping's anticipated visit to the United States in September will be confirmed and whether signs of easing technology and trade restrictions emerge before the visit. If macroeconomic data deteriorate further and prompt a significant increase in policy support in late September, both Hong Kong equities and A-shares could benefit. The macroeconomic backdrop remains one of structural divergence rather than a broad-based recovery. The report describes China's economy as an increasingly pronounced K-shaped structure: exports, technology, and advanced manufacturing are accelerating, while consumption and real estate remain stagnant, with third-quarter real GDP growth currently tracking at 4.4% year over year. Fiscal impulse is a key near-term swing factor. As of the end of July, RMB 2 trillion of fiscal and quasi-fiscal impulse remained unused for August through December, while government bond issuance accelerated in the second half of August. In real estate, secondhand home prices in Beijing, Shanghai, and Shenzhen have shown signs of recovery since February 2026, but the overall price recovery across 70 cities has been slower, residential inventory remains elevated, and the nationwide market continues to lag. The sustainability of the earnings recovery also requires monitoring. The magnitude of second-quarter earnings misses narrowed significantly compared with prior periods, but Morgan Stanley still expects consensus 2026 EPS estimates for MSCI China and the CSI 300 to be revised down further, albeit potentially at a slower pace. In terms of valuation, MSCI China trades at 10.7 times forward 12-month earnings, representing a premium of approximately 6% to MSCI Emerging Markets but still a discount to other major global equity markets. The CSI 300 trades at a corresponding P/E ratio of 13.2 times, representing a premium of approximately 23% to MSCI China. The report expects only modest and limited appreciation of the renminbi from current levels. Fund flows have not yet produced a broad-based active increase in allocations. Foreign mutual fund inflows in 2026 to date are equivalent to approximately 50% of the full-year 2025 level and remain driven primarily by passive funds. The degree of underweighting in China and Hong Kong equities among global and emerging-market active managers narrowed in July because of pullbacks in other markets, but foreign ownership of A-shares has yet to recover meaningfully. This means that the market recovery continues to depend more on passive inflows, domestic capital, and policy-driven stabilization than on broad-based active allocation increases by overseas investors. Capital supply in Hong Kong constitutes another near-term constraint. Hong Kong IPO fundraising reached US$37 billion in 2025 and US$42 billion in 2026 to date, respectively, making it one of the world's most active IPO markets. The volumes of share lockup expirations in September and July 2026 rank first and second, respectively, among all months over the past five years. Historically, months with large-scale lockup expirations have not consistently corresponded with weak markets, so the report believes the overall market impact may be limited. However, information technology and materials are the two sectors facing the greatest lockup-expiration pressure in the second half of 2026, both in absolute terms and relative to sector market capitalization, making sector-level supply shocks more noteworthy. For structural allocations over the next six to twelve months, the report emphasizes Chinese technological innovation, global export champions, and companies with high-quality business models. The global semiconductor market is expected to exceed US$1 trillion in 2026, while the expansion of agentic artificial intelligence applications, localization of artificial intelligence chips, and global investment in artificial intelligence infrastructure should benefit China's electronics, semiconductor equipment, and capital goods supply chains. Energy capital expenditure and renewable energy demand constitute a second growth theme. China controls more than 80% of key solar manufacturing segments, and the report expects China may account for 16.5% of the global export market by 2030, retaining a critical position even as supply chains diversify. Morgan Stanley's China Best Business Models v2 identifies 26 companies across 16 industry groups, emphasizing competitive advantages, industry moats, and risk-adjusted returns. From 2021 to 2025, the portfolio generated an annualized total return of 15.3% in US dollar terms, compared with -3.0% for MSCI China, with Sharpe ratios of 0.53 and -0.24, respectively. For the latest one-year period through July 2026, returns were 44.0% and -4.0%, respectively, with Sharpe ratios of 1.73 and -0.41.

Analysis framework

The report first reviews the earnings, artificial intelligence, lockup-expiration, and positioning drivers behind the Hong Kong equity rally since July, and then assesses whether these positives have already been reflected in prices. It subsequently compares A-shares and Hong Kong equities through the lenses of the global technology cycle, IPO liquidity, policy-driven stabilization, valuations, and fund flows. Finally, it combines macroeconomic fiscal capacity, real estate conditions, earnings revisions, the event calendar, historical IPO samples, and long-term export supply-chain trends to formulate a short-term market rotation strategy and medium- to long-term thematic selections.

Methodology notes

• Valuation MethodologyP/E and PEG Valuation

  12-month forward P/E ratios and cross-market relative valuation

  The report uses P/E ratios based on forward 12-month earnings to compare MSCI China, the CSI 300, MSCI Emerging Markets, and other global markets, thereby assessing the expectations embedded in current A-share and Hong Kong equity prices.

• Event Strategy and Behavioral FinanceEvent-driven analysis

  September event catalyst calendar

  The report treats artificial intelligence product launches, high-level China-US interactions, additional policy support, and Stock Connect eligibility reviews with specified dates or events as triggers for determining when Hong Kong equities may regain momentum.

• Event Strategy and Behavioral FinanceFund Flow/Positioning Analysis

  Active and passive fund flows, underweight positioning, and share lockup-expiration analysis

  The report analyzes the effects of incremental capital and potential selling pressure on markets and sectors through foreign active and passive fund inflows, active weights in regional funds, foreign ownership of A-shares, and IPO share lockup expirations.

• Quantitative/Factor/Portfolio TheorySharpe / information ratio

  Risk-adjusted portfolio performance

  The report compares the China Best Business Models v2 portfolio with MSCI China using annualized returns, volatility, and Sharpe ratios to illustrate the historical return generated per unit of risk by this stock-selection framework.

• Competitive and Strategic FrameworkMoat / competitive advantage

  China Best Business Models stock-selection framework

  This framework selects 26 companies with strong competitive advantages and industry moats from 16 industry groups, aiming to achieve more resilient risk-adjusted performance amid global macroeconomic uncertainty.

• Quantitative/Factor/Portfolio Theory

  Morgan Stanley A-Share Sentiment Index (MSASI)

  The report uses its proprietary A-share sentiment index to identify key inflection points that may correspond to regulatory intervention or technical reversals, supporting market-timing assessments.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• A-Shares and the CSI 300

  The report recommends tactically increasing attention, primarily because of the recovery in the artificial intelligence cycle, exposure to deep technology and advanced manufacturing, and market stabilization by the national team.

  Strengths

  High concentrations of advanced manufacturing, semiconductors, and hard technology, while the liquidity pressure caused by large IPOs is expected to be mainly temporary.

  Weaknesses

  The CSI 300 trades at 13.2 times forward earnings, representing a premium of approximately 23% to MSCI China; foreign ownership has yet to recover significantly.

  Comparison

  Compared with Hong Kong equities, A-shares have greater sensitivity to the global artificial intelligence and semiconductor cycles, and the report currently favors A-shares.

  Risks

  Large technology IPOs may temporarily squeeze liquidity and narrow market breadth, while the subsequent performance of newly listed stocks still requires monitoring.

• Hong Kong Equities and MSCI China

  The report recommends taking profits from the recovery rally since July and awaiting a potential new momentum window in late September.

  Strengths

  The magnitude of second-quarter earnings misses narrowed, while internet and e-commerce earnings showed signs of bottoming; if global volatility rises, Hong Kong equities may demonstrate defensive characteristics.

  Weaknesses

  The rally's drivers are largely priced in, 2026 EPS remains subject to downward revisions, and September will bring the largest volume of share lockup expirations in five years.

  Comparison

  MSCI China trades at 10.7 times forward earnings, representing a premium of approximately 6% to MSCI Emerging Markets but remaining at a discount to other major global markets.

  Risks

  The information technology and materials sectors face more pronounced supply pressure from lockup expirations, while active foreign allocation increases remain insufficient.

• China's Electronics, Semiconductor, and Artificial Intelligence Supply Chains

  The report views them as direct beneficiaries of the global artificial intelligence capital expenditure cycle and semiconductor localization.

  Strengths

  China has a deep electronics supply chain, while A-shares include a high concentration of semiconductor, equipment, and advanced capital goods companies; the global semiconductor market is expected to exceed US$1 trillion in 2026.

  Comparison

  Compared with consumption and real estate, technology and advanced manufacturing occupy the stronger side of the K-shaped economy.

  Risks

  If global markets renew their doubts about the artificial intelligence investment cycle, related sectors may face volatility.

• China's Renewable Energy and Electrical Equipment Supply Chains

  The report believes that global energy capital expenditure and renewable energy demand will support exports from Chinese supply chains.

  Strengths

  China controls more than 80% of key solar manufacturing segments and has scale and manufacturing advantages in the global energy equipment supply chain.

  Comparison

  Compared with domestic-demand-related consumption and real estate, this theme depends more on global capital expenditure and export growth.

• China Best Business Models v2 Portfolio

  The report presents it as a high-quality business-model stock-selection framework for navigating global macroeconomic uncertainty over the next six to twelve months.

  Strengths

  It covers 26 companies across 16 industry groups; from 2021 to 2025, its annualized total return in US dollar terms was 15.3%, with a Sharpe ratio of 0.53.

  Comparison

  Over the same period, MSCI China's annualized total return was -3.0%, with a Sharpe ratio of -0.24; for the one-year period through July 2026, returns were 44.0% and -4.0%, respectively.

  Risks

  The report identifies global macroeconomic uncertainty as the primary environmental risk the portfolio must navigate.

Key data

• MSCI China 12-Month Forward P/E10.7xApproximately a 6% premium to MSCI Emerging Markets, but still at a discount to other major global equity markets.
• CSI 300 Valuation13.2xApproximately a 23% valuation premium to MSCI China.
• Third-Quarter Real GDP Growth Tracking Estimate4.4% year over yearExports and technology remain strong, while consumption and real estate remain stagnant.
• Unused Fiscal and Quasi-Fiscal ImpulseRMB 2 trillionAvailable for deployment from August through December as of the end of July 2026.
• Foreign Mutual Fund Inflows in 2026 to DateApproximately 50% of the full-year 2025 levelInflows remain driven primarily by passive funds.
• Hong Kong IPO FundraisingUS$37 billion in 2025; US$42 billion in 2026 to dateThis has made Hong Kong one of the world's most active IPO markets.
• Ranking of Hong Kong Share Lockup-Expiration VolumesFirst in September 2026 and second in July 2026Compared across all months over the past five years; pressure is more pronounced in the information technology and materials sectors.
• Change in Large Technology IPO Turnover ShareDown 0.5 percentage pointsThe average change in weeks two through four after listing relative to the first week across five technology IPOs that raised more than RMB 10 billion.
• Global Semiconductor Market SizeExpected to exceed US$1 trillion in 2026Supports the long-term growth thesis for artificial intelligence and semiconductor supply chains.
• China's Share of Solar ManufacturingMore than 80% of key manufacturing segmentsDemonstrates China's critical position in the global renewable energy supply chain.
• China's Share of the Global Export MarketMay reach 16.5% by 2030The report expects artificial intelligence and energy capital expenditure cycles to drive a further increase in the share.
• China Best Business Models v2 Coverage16 industry groups and 26 companiesSelection focuses on competitive advantages, industry moats, and risk-adjusted returns.

Impact & implications

The report believes that the focus of China equity allocations should now tactically shift from the Hong Kong equity rally, where the positives have been fully reflected, toward A-shares, which have greater weights in technology and advanced manufacturing and are supported by domestic stabilizing capital. Hong Kong equities retain defensive value, but a more appropriate window for renewed attention may emerge in late September. Over the medium to long term, artificial intelligence, semiconductor localization, energy capital expenditure, and export supply chains should remain the dominant themes, while consumption, real estate, and the return of active foreign capital have yet to provide support of comparable strength.

Risks

• Global markets may become volatile again due to fiscal sustainability concerns, rising bond yields, doubts about the artificial intelligence investment cycle, or geopolitical uncertainty.
• Consensus 2026 EPS estimates for MSCI China and the CSI 300 may continue to be revised down, while the sustainability of the second-quarter earnings improvement has yet to be confirmed.
• China's economy continues to exhibit K-shaped divergence, with consumption and real estate stagnant, residential inventory remaining elevated, and the nationwide housing-price recovery lagging that of some tier-one cities.
• Hong Kong will face its largest volume of IPO share lockup expirations in five years in September, with particularly pronounced supply pressure in the information technology and materials sectors.
• Large A-share technology IPOs may temporarily squeeze market liquidity and reduce market breadth, while subsequent share-price performance may affect the duration of the impact.
• Foreign active funds have yet to broadly increase allocations to Chinese equities, and foreign ownership of A-shares has not recovered meaningfully.

What to watch

• Monitor global market conditions in late September and whether Beijing significantly increases policy support to assess when Hong Kong equities may regain momentum.
• Track artificial intelligence products, conferences, listings, and Stock Connect catalysts involving Tencent, Alibaba, Baidu, MiniMax, and Z.AI in September.
• Watch whether President Xi Jinping's anticipated visit to the United States is confirmed and whether signs of easing technology and trade restrictions emerge before the visit.
• Monitor the actual impact of large-scale Hong Kong share lockup expirations in September on capital supply in the information technology and materials sectors.
• Track the share prices, turnover shares, and market breadth following large A-share technology IPOs to confirm whether the liquidity squeeze subsides as expected.
• Monitor the pace of 2026 EPS downgrades, the breadth of earnings revisions, and whether the second-quarter earnings bottoming can be sustained.
• Track the deployment of fiscal and quasi-fiscal funds, government bond issuance, real estate inventory, and housing prices across 70 cities to assess whether macroeconomic policy needs to be strengthened further.
• Monitor whether foreign active funds, passive funds, and foreign ownership of A-shares show broader improvement.