CITIC SEC has released a research report suggesting that a rebalancing of capital flows is driving market trends from divergence to convergence. With earnings hitting a bottom and the AI narrative gaining momentum, the firm is bullish on the Hong Kong-listed internet sector. Reviewing global tech trends, the pricing focus over the past year has concentrated on the "input side" of AI infrastructure. As model capabilities continue to leap forward and commercialization paths become clearer, the pricing focus is shifting from the "input side" to the "output side," opening a window for the revaluation of Chinese AI assets. In this revaluation process, opportunities exist across three segments: cloud, models, and applications. The cloud is the first stop for AI demand realization, with high demand for computing power driving revenue acceleration and a clearer path for converting capital expenditures into revenue. Models are the core of intelligent supply; the continuous improvement in the intelligence ceiling of domestic models and the narrowing gap with global flagship models are becoming the anchor of confidence for revaluation. Applications are the vehicles for commercial realization, with scenarios, modalities, and end-devices broadening comprehensively. The breadth and depth of AI penetration continue to exceed expectations. Against this backdrop, leading Hong Kong-listed internet companies are the core assets to bear this round of revaluation. The main views of CITIC SEC are as follows:
Structural Rebalancing: The Convergence and Repair of K-shaped Divergence is Beginning
From the beginning of 2026 to date (as of July 17th, the same below), the K-shaped divergence in the domestic market has been significant: the CITIC Electronics/Communications indices have risen +35%/+32% respectively on the hardware side, while the Hang Seng Tech Index and the China Internet Index have fallen -16%/-29%, with the internet sector lagging significantly. Globally, the divergence is similarly extreme, with the SOX/KOSPI/Nikkei 225 indices up +65%/+53%/+24% year-to-date, showing significant hardware outperformance. Since July, this divergence has shown signs of loosening: the SOX has fallen -18% cumulatively, while Microsoft/Amazon/Google/Meta have gained +2.5%/+2.3%/-4%/+5.4% over the same period, and the Hang Seng Tech/China Internet indices have risen +3.4%/+12%. The firm believes the K-shaped divergence is gradually moving towards convergence and repair. Overly crowded hardware positions, coupled with the unfolding narrative of Hyperscalers' model commercialization and expected recovery, are leading global capital structures to gradually shift from hardware to cloud and applications. Hong Kong-listed internet stocks, with their low positioning and undervaluation, are expected to become an important destination for this capital shift. The firm is optimistic about the sector's convergence and recovery trend.
Flow Rebalancing: Capital is at Low Levels, and Momentum for Return is Building
Feedback from recent roadshows with overseas investors indicates that current mainstream positioning involves underweighting China and, within Chinese assets, underweighting the internet. Since July, volatility in the Asia-Pacific hardware sector, represented by memory, has increased significantly. The KOSPI/Nikkei 225 have fallen -18%/-9% cumulatively since July, with Samsung Electronics/SK Hynix/Kioxia down -19%/-28%/-41% respectively. High volatility in Japanese and Korean markets may drive regional capital reallocation, benefiting Hong Kong internet stocks with their low positioning and undervaluation. Coupled with the further rise of the Chinese AI narrative, hedge funds that previously employed a "long tech, short internet" strategy and long-term foreign capital underweighting China and the internet may have motivation to rebalance their portfolio structures. Momentum for foreign capital return is building. On the domestic capital side, according to Wind, Hong Kong ETF funds have also seen continuous net outflows of 5.4/43.1 billion yuan since July/from the beginning of the year. Domestic capital's overall allocation to the internet sector remains at low levels. The sector's capital situation is currently in a "double low" state, with both types of capital having the motivation to increase positions. Subsequently, as rebalancing progresses and AI catalysts materialize, there is clear upside potential for capital flows.
Earnings Perspective: Pessimistic Expectations are Priced In, Profit Inflection Point Expected in H2 2026
Since 2025, the main reason for the adjustment in the Hong Kong internet sector has been EPS downgrades, primarily due to revenue pressure from macroeconomic headwinds, as well as profit pressure and uncertainty from AI and new business investments. As of July 17th, the consensus earnings growth expectations for the Hang Seng Tech Index for 2026/2027 are 11%/22%. The firm believes pessimistic expectations are now relatively fully priced in, with losses in traditional businesses, represented by instant retail, clearly and rapidly contracting. According to Visible Alpha consensus, the combined revenue of major domestic internet companies in Q2 2026 is expected to grow +5% year-on-year, continuing steady growth. Combined Non-GAAP net profit is expected to decline -8% year-on-year, a significant narrowing from the -32% drop in Q1 2026, indicating a marked quarter-on-quarter improvement in profitability. Non-GAAP net profit growth is expected to further recover to +12%/+46% in Q3/Q4 2026, with full-year 2026 combined revenue growth expected at +8%. Sector earnings growth has bottomed out. The improvement in core business profitability is expected to further support continued investment in AI businesses. As AI business models gradually clarify, a positive cycle of "core business generating cash — funding AI investment — growth realization" is forming. The quarter-by-quarter repair of EPS expectations not only provides a margin of safety at current levels but is also expected to become an upward catalyst for the sector's performance. Attention is advised on the pace of earnings releases from internet companies.
Valuation Perspective: Domestic AI Narrative Restarts, Overseas Capital Revaluing Chinese AI Assets
The recent release of Kimi K3 has sparked significant overseas reaction. With high ROI, the catch-up time lag for Chinese vendors relative to overseas flagship models has shortened to about 3 months, leading the market to discuss whether this is a "second DeepSeek moment." The firm believes K3's performance is the first recent instance of accelerated domestic AI catch-up. In the second half of the year, Chinese model vendors will enter a new intensive iteration cycle, continuously challenging global flagships in terms of intelligence ceiling and cost-effectiveness, aiding the shift from "following" to "running alongside." Secondly, following the recent WAIC conference, upstream computing power is accelerating iteration in super-nodes, interconnects, and adaptation for domestic models. Downstream applications are flourishing, covering more diverse scenarios (office, programming, embodied AI, consumer entertainment, etc.), richer modalities (text, image, video, audio all blossoming), and accelerating extension to end-devices (AI phones, glasses, robots, etc.). The breadth and depth of AI penetration continue to exceed expectations. The improvement in the intelligence ceiling of Chinese models and the high certainty of downstream commercialization will prompt overseas investors to re-examine the competitive advantages and valuation potential of Chinese model companies. This revaluation is expected to spread from the primary market to cloud and model-related assets in the secondary market. Currently, the Hang Seng Tech Index's NTM PE is 18.9x (Wind consensus), at the 27.5th percentile over the past five years. With earnings bottoming out and the AI narrative gaining resonance, the sector has room for both valuation and earnings recovery.
Risk Factors
Liquidity easing falling short of expectations leading to a decline in the market valuation anchor; internet companies' cost-cutting and efficiency improvements falling short, leading to weaker-than-expected earnings recovery; slower-than-expected expansion into new businesses and markets, or investment losses exceeding expectations; risks such as share reductions by major shareholders; slower-than-expected policy implementation; domestic large models' catch-up speed with foreign peers falling short of expectations.
Comments