28 October 2016
Hong Kong stocks could rise further if Beijing's policy environment remains benign. Photo: HKEJ
Hong Kong stocks could rise further if Beijing's policy environment remains benign. Photo: HKEJ

How much upside is left in the Hang Seng Index?

How long can the Hong Kong stock market rally sustain?

One can put this matter to debate, but the indicators now leave us with enough room for optimism.

Technical analysis shows that the Hang Seng Index has managed to break over a multi-year resistance level, setting it on course for greater heights. With active investor participation, the party could carry on for some time.

However, central government policy is the main catalyst for this round of liquidity-driven market run-up. Therefore, the bull phase is very much dependent on the broad guidance from Beijing.

In the end we have to admit that the current rally has very little to do with fundamentals, relying instead on Chinese policy hopes.

Beijing has tried to buoy up the stock market as part of efforts to help Chinese companies raise funds through the capital market. However, the across-the-board rally in the Hong Kong market has been mainly driven by an influx of hot money.

Certain stocks have benefited from the market boom without solid support from company earnings.

Therefore, we might see a wave of share placements and fund-raising activities as the stock market hits a peak.

Historical study shows that fund-raising activities usually have close link with stock market trend. Simply speaking, the market is very likely to level off as huge amount of capital is drained away by active fund-raising moves.

Currently, listed firms have raised HK$100 million on average through right issues over the past 25 weeks, up from HK$40 million in late 2013. But the figure still lags behind the peak level of HK$150 million and HK$200 million in 2007 and late 2010 respectively.

The data suggests that the market still has further room to go up.

Assuming that supportive policies remain in place in the short term, we can calculate the potential upside of the Hong Kong market from two gauges.

One relates to the adjusted price-to-earnings ratio. 

HKEJ’s Cyclically Adjusted Price Earnings Ratio (CAPE) has hovered around 11 to 13 times since 2011. The benchmark may test the record high of 16.5 times we’ve seen in 2010 and 2011 as the Hang Seng Index hits new threshold post the financial crisis. If that’s the case, the Hang Seng Index still has 35 percent upside and could peak at 37,300 points.

The other gauge is in relation to housing prices. 

Housing prices have moved very closely with the stock market over the years. The correlation remains in place after the financial crisis. However, we’ve seen a decoupling between the two since the second half of 2011, due in part to counter-cyclical measures adopted by the government.

The Centa-City Leading Index has surged 150 percent since 2009, while the Hang Seng Index only gained 92 percent in the period. If the Hong Kong market is in the middle of catch-up with the property market, the Hang Seng Index will have another 30 percent rally, taking the benchmark to 36,000 points.

This article appeared in the Hong Kong Economic Journal on April 16.

Translation by Julie Zhu

[Chinese version中文版]

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Hong Kong Economic Journal chief economist and strategist

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