Morgan Stanley recommends adding Hong Kong exposure again from July to September

Overview

This is a Morgan Stanley China equity strategy report centered on the theme of “adding Hong Kong exposure again.” The report covers Chinese and Hong Kong equity markets, MSCI China, the Hang Seng Index, the CSI 300, foreign fund holdings, IPO unlocks, relative valuations of A-shares and Hong Kong stocks, and medium- to long-term opportunities in China's technological innovation and export supply chains.

Core views

The report believes July to September 2026 will be a rebound window for the Hong Kong market. Supporting factors include bottoming earnings pressure in internet/e-commerce, regulatory efforts to reduce price competition, new large language models and AI functions easing concerns about capital expenditures by large Chinese internet companies, the gradual absorption of earlier IPO unlock pressure, and continued significant underweighting of Chinese/Hong Kong equities by global investors. Meanwhile, A-shares have greater exposure to semiconductors and hard technology and are more correlated with the global AI cycle, so short-term volatility may be higher.

Analysis framework

The report uses a top-down equity strategy framework, combining index valuation, earnings estimate revisions, industry allocation, active/passive foreign fund flows, A/H relative valuation, IPO financing and unlocks, high-frequency real estate indicators, policy and fiscal room, and the performance of thematic stock portfolios.

Methodology notes

• Equity StrategyTop-Down Industry Allocation

  Assessing market and industry weights through macroeconomic conditions, earnings, valuation, and fund flows.

  The report compares the Hong Kong market, A-shares, and MSCI China within the context of global markets, the AI cycle, fund positioning, and the policy environment, leading to strategic recommendations to add Hong Kong exposure and selectively invest in industries in the short term.

• Fund Flow AnalysisTracking Active and Passive Foreign Fund Holdings

  Observing the portfolio weights and changes of global, emerging-market, and China funds in Chinese/Hong Kong equities.

  The report notes that global and emerging-market active funds remain significantly underweight Chinese/Hong Kong equities, implying room for further buying if fundamentals improve.

• Thematic InvestingChina Best Business Models

  Selecting Chinese companies with competitive advantages, industry moats, and attractive risk-adjusted returns.

  The report presents the portfolio's advantages over MSCI China in returns and Sharpe ratios over the past one, three, and five years, as a means of navigating global macroeconomic uncertainty.

Asset mapping & comparison

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

• Hong Kong Equity Market

  Recommend adding exposure

  Strengths

  Earnings pressure has bottomed, internet fundamentals are improving, global investors remain underweight, and correlation with global AI trades is relatively low.

  Weaknesses

  Still vulnerable to external risk appetite, unlocks, and liquidity events.

  Comparison

  Relative to A-shares, the Hong Kong market is more likely to benefit in the short term from low positioning and fundamental recovery.

  Risks

  Sharp global market volatility, failure of fund flows to return, and renewed earnings downgrades.

• A-Shares/CSI 300

  Relatively cautious

  Strengths

  High concentration in advanced manufacturing, semiconductors, and hard technology, with potential support from national funds.

  Weaknesses

  Highly correlated with the global AI cycle, while the CSI 300 trades at a relatively high valuation premium to MSCI China.

  Comparison

  Short-term volatility may be higher than in Hong Kong stocks.

  Risks

  A cooling global AI trade and near-term volatility following the CXMT IPO and subsequent performance of large technology IPOs.

• Internet/E-commerce

  Recommend adding back in the short term

  Strengths

  Easing price competition, second-quarter earnings pressure likely bottoming, and the integration of AI functions into ecosystems improving expectations.

  Weaknesses

  Still facing uncertainty related to regulation, competition, and returns on capital expenditures.

  Comparison

  A key industry in the Hong Kong rebound trade.

  Risks

  Renewed price competition, failure to convert AI investment into earnings, and weak consumption.

• Export Chain, Electronics, and Renewable Energy Supply Chains

  Beneficiaries over the medium to long term

  Strengths

  China is strongly positioned in the global AI/energy capital expenditure supply chain and controls more than 80% of key solar manufacturing segments.

  Weaknesses

  Exposed to external demand, trade frictions, and export controls.

  Comparison

  Compared with domestic consumption and real estate, exports and advanced manufacturing remain growth bright spots.

  Risks

  A slowdown in global demand, geopolitics, and tighter export restrictions.

Key data

• MSCI China Valuation10.7x 12-month forward P/EApproximately a 7% premium to MSCI EM, but still at a discount to major global equity markets.
• CSI 300 Valuation13.7xApproximately a 30% valuation premium to MSCI China.
• Hong Kong IPO FinancingUS$37bn in 2025, US$42bn year-to-date in 2026Hong Kong has become one of the world's most active IPO markets.
• Second-Quarter EarningsEarnings pressure is easingThe report believes 2Q26 guidance indicates easing earnings pressure, with the internet/e-commerce sector benefiting particularly.
• Fiscal RoomApproximately Rmb2trnAs of end-June, unused budgetary and quasi-fiscal stimulus remained available for the second half of the year.
• China's Export ShareCould reach 16.5% of the global total by 2030The report believes AI and energy capital expenditure supercycles will benefit China's electronics and renewable energy supply chains.

Impact & implications

The investment implication is that Hong Kong market and internet exposure can be increased in the short term to capture a recovery rally, while investors should monitor the transmission of a global AI-trade correction to volatility in A-share hard technology and semiconductor sectors. Over the medium to long term, the preference remains for technological innovation, high-quality business models, global export champions, power equipment, and renewable energy supply chains.

Risks

• Increased global market volatility leading to weaker risk appetite.
• Chinese/Hong Kong corporate earnings downgrades failing to slow as expected.
• Renewed price competition in the internet and e-commerce sectors.
• Short-term liquidity shocks caused by large IPOs or unlock events.
• Still-high real estate inventories, with domestic consumption and property recovery lagging.
• Export controls, U.S. executive orders, or geopolitical restrictions affecting trading in related securities.

What to watch

• Whether economic activity and policy implementation improve from July to August.
• Whether additional easing policy signals emerge before September.
• Earnings revision trends for internet, e-commerce, and MSCI China companies during the 2Q26 earnings season.
• Whether foreign active funds shift from underweighting to adding Chinese/Hong Kong equities.
• How the market absorbs the Hong Kong IPO unlock month.
• The impact of a global AI-cycle adjustment on A-share semiconductor and hard technology sectors.