1.”Catching Up” Is More Accurate Than “East Rises, West Declines”
Prior to the Lunar New Year, we highlighted the potential for a revaluation of the Hang Seng Index, driven by the view that markets overestimated tensions in U.S.-China relations under Trump’s new administration. Post-inauguration, Trump’s policy rhetoric—limited to a proposed 10% tariff hike and signals of a China visit within 100 days—has been muted, aligning with our early assessment of a significant rebound in the Hang Seng.
The Hang Seng Tech Index, which plunged from 10,000 points in 2021 to a low of 2,000 due to China’s “capital traffic light” policy (restricting unchecked private-sector expansion), has stabilized post-holiday. The resurgence of Alibaba’s Jack Ma in public forums marks the end of regulatory tightening on private enterprises, accelerating the Hang Seng Tech’s valuation recovery and bolstering mainland equity markets.
While DeepSeek’s V3 AI model drew discussions in early December, it was the January 22 release of the R1 model that triggered a divergence in global AI equities: U.S.-listed AI stocks (e.g., Nasdaq giants) corrected sharply, while Chinese and Hong Kong AI-related firms surged. This reflects China’s structural catch-up in the global AI race rather than a simplistic “East over West” narrative.
The narrowing valuation gap between China’s “Top 10 Tech Leaders” and the U.S. “Magnificent Seven” (e.g., Microsoft, Nvidia) is driven by fundamental catch-up, not speculative momentum. From a quarterly perspective, the upside for Chinese tech valuations remains intact, with sustained bullish momentum expected this year. The core catalyst remains the end of regulatory overhangs.
In summary, this phase is defined by China’s catch-up—not a binary “East rises” shift—given lingering gaps in hardware and software innovation compared to the U.S. The “East rises” narrative, amplified by international investment banks, lacks credibility. Trump’s abrupt reversal on RMB forecasts (from predicting a plunge to 8.0 to touting China’s economic resilience) further undermines confidence in such geopolitical framing.
2. A Significant Shift in Global Market Dynamics
Since the Lunar New Year, the smooth rally in European markets has further undermined the “West Declines” narrative. In the Asia-Pacific region, South Korea has experienced a recovery, while Japan’s equity market has underperformed due to rising interest rates. Latest economic data show Japan’s inflation reaching 4%, quarter-on-quarter GDP growth at 0.7%, and an annualized rate of 2.8%, signaling an overheated economy. Markets now anticipate the Bank of Japan (BoJ) to accelerate its rate-hiking pace. We believe the 10-year Japanese government bond (JGB) yield faces no upward pressure until 1.75%, and equity market gains will remain constrained. Against the backdrop of weak Asia-Pacific performance, it is logical for international hedge funds to significantly increase their holdings in Hang Seng Tech.
From a purely macroeconomic perspective, global trading logic remains anchored to inflation. The latest U.S. inflation data stands at 3%, with the UK matching this level, though the magnitude of this renewed inflationary uptick remains uncertain. This has weighed on U.S. equity performance. However, aggressive dovish signals from Europe and the UK—despite accelerating inflation—have fueled a sharp equity rebound. The critical test for central bankers lies in whether they will maintain these rate-cut expectations amid persistent price pressures. We expect post-German election shifts to rapidly dampen dovish expectations, marking a turning point for European equities. While the notion of monetary policy serving political agendas may sound conspiratorial, its influence cannot be dismissed.
In a global inflationary environment, economies with robust growth and capital expenditure resilience to higher rates will emerge as winners. This explains the U.S. scenario: rising inflation coexists with a red-hot labor market and tightening financial conditions. The “West Declines” narrative remains ill-fitting. European equity valuations now appear stretched post-adjustment.
In China, recent inflation data hints at reflationary momentum, with narrowing year-on-year declines in property transactions. Sustained equity market gains and the 10-year government bond yield reclaiming 1.7% reflect expectations for gradual inflation acceleration. However, exiting deflation fully requires further efforts. Surging property transaction volumes are improving liquidity for real estate firms, and state-backed housing inventory purchases—albeit at steep discounts—are enhancing market fluidity. While increased liquidity may ease price declines, the sustainability of this adjustment hinges on upcoming economic data. We maintain an optimistic outlook for China’s financial markets this year.
3. Expectations for the Two Sessions
As China’s inflationary pressures gradually intensify, it is critical to recognize that this trend stems not only from organic improvements in market trading activity but also from the lingering tailwinds of monetary and fiscal policies implemented in Q4 2024. Historically, such policy-driven momentum lasts 1–2 quarters, meaning its effects will likely fade by the end of Q1. The first signs of this slowdown will emerge in declining growth rates for durable goods consumption, such as automobiles, home appliances, and personal electronics.
This necessitates stronger fiscal and monetary stimulus at the Two Sessions in March. Fiscal policy retains significant flexibility, with market expectations pointing to RMB 10 trillion in new stimulus measures, including special bonds, expanded central fiscal deficits, and special treasury issuances. Notably, China’s non-tax revenue reached RMB 4.5 trillion in 2024, which introduces material uncertainty for 2025 and warrants caution. Meanwhile, the appreciation of the RMB and the revaluation of mainland and Hong Kong equity markets have expanded the scope for monetary easing. We anticipate the central bank will prioritize reserve requirement ratio (RRR) cuts in H1, followed by a rate-cut cycle in H2, contingent on the efficacy of earlier liquidity measures.
Key Projections:
Fiscal Deficit Ratio: The central fiscal deficit is expected to reach 4% of GDP, with funding for “Two New” projects rising to RMB 500 billion (vs. RMB 300 billion in 2024).
Monetary Policy: Two RRR cuts totaling 50bps in H1, with rate cuts in H2 dependent on inflation and growth dynamics.
Conclusion: The stimulus package unveiled at the Two Sessions must at least match the intensity of Q4 2024 to sustain economic momentum. Policymakers face a delicate balance between countering deflationary risks and avoiding overheating, particularly as property market liquidity improves via state-backed inventory purchases (albeit at steep discounts). Vigilance on non-tax revenue volatility and global inflationary spillovers remains paramount.