SWS Research suggests that the Hong Kong stock market is currently in a "triple bottom" zone, underpinned by a combination of persistently declining institutional allocations, a bottoming-out of fundamental expectations, and a deep valuation correction in the technology and growth sectors, providing foundational conditions for a potential recovery.
SWS's strategy team noted in a July 16 report that recent positive shifts in both macro catalysts and industry narratives could help propel the market out of this trough. The Hang Seng Index fell 10.73% in the first half of 2026, while the Hang Seng Tech Index dropped more sharply by 18.92%. At the sector level, only industrials, conglomerates, and financials recorded positive returns, with materials and non-essential consumer sectors declining over 25%.
According to SWS's ERP model projections, the Hang Seng Index has a potential upside of 15.40% for the year under a neutral scenario, assuming a 2% earnings growth rate for 2026 and a 10-year US Treasury yield of 4.30%. Concurrently, the outstanding short positions in Hong Kong stocks are at historically extreme highs, suggesting that a market reversal could trigger short-covering, providing additional upward momentum for the indices.
The First Bottom: Sharp Decline in Institutional Allocations
Mainland capital allocation to Hong Kong stocks saw a significant ebb in the first half of 2026. Southbound funds recorded a net inflow of only about HKD 301 billion, less than 22% of the full-year 2025 total and under 38% of the 2024 total. The average daily turnover of Stock Connect as a percentage of the total market shrank rapidly from a historical high of around 25% in 2025 to approximately 21%.
Actively managed public funds have been a key driver of this downturn in Hong Kong allocations. As of the end of Q1 2026, the Hong Kong stock weighting of active public funds primarily focused on A-shares but also permitted to invest in Hong Kong had fallen to 13.9% from a peak of nearly 20% in mid-2025, a drop of about 6 percentage points, indicating a clear trend of "redeeming Hong Kong for A-shares." SWS expects this ratio to continue declining in Q2, potentially approaching the 10% level seen in 2022-2023.
The selling pressure is also spreading to long-term capital. Mainland-listed Hong Kong tech-themed ETFs shifted to net redemptions starting in April, with the net redemption amount in June alone expanding further to over RMB 40 billion.
Among overseas investors, as of the end of May, the allocation to Chinese mainland and Hong Kong assets by actively managed emerging market funds and Asia-Pacific funds had retreated to levels last seen at the end of August 2024. In contrast, allocations to South Korean and Taiwanese equities have reached or are near historical highs.
The Second Bottom: Fundamental Expectations Stabilize Post-May
The downward revision in EPS expectations for the Hang Seng Tech Index hit a record high for the period in mid-May this year, primarily due to sustained pressure on internet platform companies' net profits from factors like "food delivery subsidies," "cut-throat competition," and rising AI capital expenditures. However, following the conclusion of the Q1 earnings season in late May, EPS expectations for the index showed clear signs of stabilization.
From a sector perspective, significant earnings expectation adjustments for most industries were concentrated in the first four months of the year, stabilizing after May. Retail and property sectors saw the largest downward revisions in earnings expectations, while sectors like materials, energy, financials, and pharmaceuticals & healthcare recorded overall upward revisions.
Notably, the pharmaceuticals & healthcare and non-bank financial sectors exhibited a divergence of "upward earnings revisions coupled with falling stock prices." For non-e-commerce platform companies, including sub-sectors like media & entertainment, consumer services, and commercial services, stock price declines were several times greater than the concurrent downward revisions in earnings expectations, indicating particularly pronounced valuation corrections.
The Third Bottom: Deep Valuation Trough for Tech and Growth
On the valuation front, SWS points out that the current market is characterized by "technology and growth sector valuations retreating to historical lows, with broad-based index valuations also showing significant declines."
The ERP of the Hang Seng Tech Index briefly approached levels seen in late 2024 during the rapid market sell-off in mid-to-late June. Comparing valuation percentiles for Hang Seng sector indices since 2020, valuations for some indices in the technology, consumer, and healthcare sectors by the end of June were lower than levels prior to the September 24, 2024 market surge, indicating this valuation bottom is primarily defined by deep troughs in tech/growth and domestic demand sectors.
Broad-based indices have not been spared either. The ERP for the Hang Seng Index surged to around 6.5% in mid-to-late June; the last time it reached this level was during the global trade friction shock in early April 2025.
Extreme Short Positions as a Potential Rebound Catalyst
SWS believes the most distinctive market structure feature of this Hong Kong market bottom zone is the simultaneous high levels of short-selling volume and trading activity. Excluding Stock Connect turnover, the proportion of short-selling to total market turnover has remained above 20% for several months. The outstanding short position amount in Hong Kong stocks has continued climbing since breaking through its historical upper limit in early 2025 and is currently at an extreme, unprecedented high.
The report attributes this phenomenon to four factors:
First, the average daily turnover for Hong Kong stocks expanded from HKD 1,318 billion in 2023 to approximately HKD 2,605 billion from 2025 to the first half of 2026, with market capacity expansion naturally lifting short-selling scale.
Second, the overall short-selling ratio in the market has increased.
Third, a rapid expansion in structured product trading – the average daily turnover for derivative warrants rose 48% year-on-year in 2025, while that for bull/bear certificates rose 59%. In H1 2026, the average daily turnover for bull/bear certificates maintained a 35% year-on-year increase, requiring market makers to hedge with short positions in the cash market.
Fourth, some regional hedge funds have adopted a "long AI hardware, short Chinese software/consumption" strategy this year, contributing significant short-selling volume in the Hong Kong market.
SWS notes that should fundamentals or global sector preferences reverse, the covering of these substantial short positions could provide significant elasticity to the market's upward movement.
Macro and Industry Catalysts for Recovery
On the macro front, SWS points out that against a backdrop of reduced participation from Southbound investors, Hong Kong stocks' sensitivity to US bond yields and overseas liquidity conditions has increased markedly, with the negative correlation between US Treasuries and Hong Kong stocks at a significant level. Meanwhile, the State Council recently approved the "15th Five-Year Plan for Expanding Consumption," explicitly focusing on new consumption demands in elderly care, childcare, culture & tourism, and health, and making institutional arrangements to promote service consumption and develop digital consumption. Service consumption and new consumption are signature sectors for Hong Kong stocks, and the implementation of related policies could aid in the repair of fundamental expectations.
On the industry front, SWS believes a shift in narrative within the technology sector could be a key driver of changes in global market trading themes in the second half. On one hand, global AI hardware trading is constrained by multiple factors including deteriorating financing conditions, concerns over computing power oversupply, unclear AI commercialization paths, and crowded trades, increasing the probability of a trading style reversal in H2. On the other hand, the core profitability of Chinese internet companies is gradually stabilizing under the influence of anti-"involution" policies, and substantial progress has been made in AI productization and commercialization, representing a clear improvement from the Q2 situation of "persistent downward revisions in core business expectations + AI investments eroding profits with no visible returns." Additionally, domestic substitution in the computing hardware field also contributes to a broader re-rating of Chinese tech assets.
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