Worst may be over for Hong Kong stocks – it’s time to buy

Shares on the Hong Kong bourse offer excellent value and the market will receive unstinting support from Beijing
While the US and European markets are outperforming Hong Kong’s now, their ability to keep inflation down relies on the weakness of China’s post-Covid economy

Richard Harris

Published: 5:30am, 2 Feb 2024

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Hong Kong has almost always been cheap. I’m not talking about the cost of housing or the prices in the supermarkets – but the value of the stock market. For the decades leading up to the handover in 1997, the Hong Kong market was consistently one of the cheapest in the world, as measured by the time-honoured ratio of share price to company earnings (P/E).

Scores of investors – usually those who think of themselves as “masters of the universe” – were caught out thinking that the market would always rise to match global valuations.

Hong Kong was cheap, despite its superb economic growth in the 1980s and 1990s, because of the uncertainty regarding the handover – and markets don’t handle uncertainty well. That anomaly disappeared as the post-handover period finally saw P/E ratios catch up with those elsewhere.

Moving to today, the Hang Seng Index has fallen four years in a row, and Hong Kong’s stock market capitalisation fell below India’s for the first time. A week ago, the market slid to a 15-month low, losing more than 12 per cent since the beginning of this year, and, shockingly, over 50 per cent from the January 2018 peak.

This was capitulation – the point at which everyone gives up. Oh, to have bought some call options at that stage. The worst thing an investor can do is to know that they have the right investment idea – and not execute the trade.

For the next day, following Beijing’s pledge of “forceful” measures to support the stock market, the Hang Seng bounced 2.6 per cent on the day and 8.4 per cent over three days. Other measures have also been announced to support and reflate the Chinese economy, including a cut in the reserves that banks have to hold, expanding funding for developers, and tightened controls on short selling.

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Hong Kong stock market falls below 15,000 level, its lowest in 15 months

These measures, as well as those taken over the past few months, have given considerable support to the US$18 trillion economy – a sizeable proportion of which should flow into share prices.

These columns have been forecasting this action and the consequent market bounce because few governments watch a sluggish economy and do nothing. Until now, the mainland authorities have acted cautiously, wanting to avoid the so-called law of unintended consequences.

The West has injected a great deal of liquidity into its economies to stave off recession, as seen by the extraordinary rise in US and European markets. In the past two years, the US market has outstripped Hong Kong by over 44 per cent.

The irony is that the European and US markets have been supported by the weakness of the post-Covid China economy. The US Federal Reserve prides itself on reducing inflation but, in reality, it is China’s exported deflation that has given the US such positive growth with only moderate price rises.

Global disinflation has been encouraged by the lower prices of goods and services sold to the world from China, the falling value of the renminbi, and because sluggish domestic demand has lowered global commodities prices.

This also explains the mystifyingly cheap oil price, considering that two major wars are raging, the Suez Canal is effectively closed, and a lack of water is throttling the Panama Canal. In short, a crassly loose interest rate policy and high public spending in the West are being bailed out by China. The link between economic growth and inflation is not dead – it’s just sleeping.

Given the increasingly large stimulus being injected into it, a Chinese market recovery is probably at hand. This is likely to lead to exported inflation and renewed worries in the US of Fed action to increase interest rates. According to this forecast, China would recover while the US and Europe markets would slide.

Beijing needs a better strategy to defend Hong Kong’s status as financial hub

However, the narratives don’t always work like that. There is still room for a year of optimism in Western economies, even in an environment of rising prices. That is, until reality sets in – and reality looks like a story of critical market fragility ending in a debt crisis. We are still in the midst of a long and extended party before the lights come on and the hangover begins.

In the meantime, the Hong Kong economy and market is behaving like a warrant on the Chinese markets. That is, it does worse than the mainland when China does badly and better than mainland China when it does well. The path to recovery is not smooth – as the liquidation of China Evergrande ordered by a Hong Kong court this week has shown.

However, Hong Kong shares are of extraordinary value, trading at a 36 per cent discount to mainland stocks, and are cheap in P/E terms, with most blue chips yielding more than 5 per cent.

It does not do to shout these things from the rooftops – after all, one might be wrong, but it looks like we might have seen the lows of this cycle. The markets do their best to embarrass the most brave of pundits. Yet perhaps it really is time to speak softly and say, “It’s time to buy Hong Kong”.

Dr Richard Harris is chief executive of Port Shelter Investment and is a veteran investment manager, writer and broadcaster, and financial expert witness