We give our reasons and cite some articles that discuss LR and Hypothesis in the same section
(PS: one assumes that the bulk of articles you cited are from journal A)
Personally, I don't like being put down on semantics of paper style, however, at times, reviewers comments are indicators that we are not communicating well enough.
So writing in explicit mode with (lay reader) clarity is an art we perfect each time.
Should literature review and hypothesis be in the same section, that I can't comment on as we are not privy to your manuscript, (nor to your field/discipline).
Can it be, it's possible. Can LR and hypothesis be split, yes they can. In this instance, we can't say.
I just feel so upset with the editor. Shall I appeal or move it on. B journal
Simply put, relax, keep calm and re-read with open mind.
After a week or even a month, print and re-read your manuscript again. After that, likewise, re-read the reviewers comments with open mind. Then take another look at your manuscript.
Do all of this away from your desk/computer.
It might be the reviewer is off-tangent. It might be the reviewer is pedantic. It might be the reviewer got it all wrong. Yet, it might be there're golden nuggets in the comments that might yield invaluable benefits to the manuscript.
It might be, just maybe, you're not communicating well enough. At times, we oft get lost in the authors mind mode. We see what we're writing but we don't see what we're not communicating.
So calm down, read again.
Should you appeal, my understanding is that you engagement with the EiC is the appeal. If you feel otherwise, there's no harm in writing a formal appeal and await the outcome: Be calm, professional and scientific about it. (No emotions)
Should you move the manuscript on to paper B.
After the calming down process (as outlined), improve the manuscript and resubmit.
Rejections are fabric we all wear with pride as academia. Obviously, some review process (and some reviewers) can be bad experience. We shroudshake 'em off and move on with purpose.
[Edit]
"we argued with more evidence*
Most of this evidence effort should also reflect in the manuscript (and not only in the appeal/rebuttal). I'm just indicating (for future readers), just in case it doesn't