27 October 2016
Retailers could face more uncertainties next year after a business slowdown in 2015. Photo: Bloomberg
Retailers could face more uncertainties next year after a business slowdown in 2015. Photo: Bloomberg

Why we should take year-end forecasts with a pinch of salt

With just about five weeks to go before we bid goodbye to 2015, we can expect the usual flurry of predictions for the coming year.

While the forecasts will draw much interest, it is also a good time to take stock of the previous record of the crystal ball gazers.

Looking back, we can see that most of the year-end projections in 2014 have turned out to be off the mark.

For example, the US did not raise interest rates in mid-2015, contrary to forecasts. With regard to China, there had been no warnings about the yuan’s devaluation. Also, no one predicted that Hong Kong and China markets would fall sharply after the big rally earlier this year.

It’s always difficult to make predictions, as people usually believe things will continue as they used to be. People tend to move with the consensus, rather than go against the crowd.

This can be seen in the predictions made last year for resources prices.

As prices had already fallen sharply since the third quarter of last year, analysts believed that the sector will not suffer further losses. But in reality, oil price tumbled from US$90 a barrel in the fourth quarter of 2014 to below US$50 at present.

When price diverges from the fundamentals or value, it’s usually seen as a good buying opportunity. Fundamentals usually won’t change dramatically within a short time, but the market thinking will be hard to change.

Many investment banks have mentioned mounting deflationary pressure in China. However, none of them have predicted that the CPI will swing to negative territory next year, although it already fell to 1.3 percent in October.

In Hong Kong, inflation dropped to 2.4 percent in October, and local retailers have been scrambling to boost sales with 5 to 10 percent discounts. The discounts may help boost sales volume, but they could cut the profits by as much as half.

Take a look at Chow Tai Fook Jewelry (01929.HK). The company saw its interim revenue drop by 4.1 percent to HK$28.1 billion, but its profit slumped by as much as 42 percent to HK$1.56 billion.

Elsewhere, cosmetics retailer Sa Sa International (00178.HK) said its interim profit slide by 55 percent to HK$150 million, even as revenue only fell 10.6 percent to HK$3.7 billion.

Profitability is getting eroded as retailers are forced to cut prices even as costs remain elevated.

Retail and consumption are the last hopes underpinning China’s economic growth. If that hope is shattered, how will the stock markets respond?

Taking a broad view, we can expect some stocks to outperform the overall market. Any negative prognostication for the coming year shouldn’t mean that all sectors will move in the same direction.

New-economy firms have stronger pricing power and will beat the rest of the market.

Warren Buffett once said: “In business, I look for economic castles protected by unbreachable moats.”

Now, how do we define unbreachable moats?

Well, a company can be said to have such a moat if its customers stay with the firm even if it doubles its prices.

Look out for such firms in the new-economy space.

This article appeared in the Hong Kong Economic Journal on Nov. 25.

Translation by Julie Zhu

[Chinese version中文版]

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Columnist at the Hong Kong Economic Journal

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