According to some Feng Shui masters, the Year of Monkey will be a year of strife and turbulence. The choppiness we have seen in the mainland and Hong Kong financial markets in the run-up to the Lunar New Year seems to only confirm the prediction.
The A-share market has fallen by about 20 percent since Jan. 1. The renminbi and Hong Kong dollar (HKD) have both weakened, sparking fears of a sustained depreciation trend of the currencies. China’s devaluation of the renminbi is a root cause of the current global market volatility.
We believe Hong Kong will retain its currency peg to the US dollar. The real problem is the HKD interest rate, as it is likely to rise due to the US Federal Reserve’s tightening stance. It is possible that Hong Kong banks will start raising interest rates in April or even earlier.
While the credit, real estate and economy cycles have peaked out in Hong Kong, the risk is from a devaluation pressure on HKD and the potential rise in local borrowing rates.
The two factors will suppress the real estate market and possibly lead to larger capital outflow from the city. As larger capital outflow will, in turn, exert bigger devaluation pressure on HKD, a loop is formed. If this turns true, the Hong Kong stock market will suffer because banks, developers and financial stocks make up over 60 percent of the overall market cap.
We expect HKD to remain in the range of 7.75 to 7.85 against the US dollar, while the hibor rate will increase in line with the US rate movements.
Due to rising borrowing rates and downside risks for home prices, we prefer the telecom sector, companies with quality overseas businesses or stocks that come at a big discount.
Be it from a horizontal or vertical perspective, the MSCI China index is very attractive now. Its 12-month expected price-to-book ratio is below 8 times, lowest among Asian indexes, and is below the level seen during the global financial crisis.
Although market sentiment is very passive now, it is expected to improve after the market gets used to the renminbi’s new pricing system and the economic transformation in China.
MSCI China is likely to have positive return in the year, so we maintain an overweight stance on the segment, compared to Asia (ex-Japan) stocks.
We prefer stocks with stable industry outlook and low exposure to the “old economy”. The list includes healthcare, insurance, Internet, advanced manufacturing, new-energy and consumer goods.
Meanwhile incentive policies can also benefit certain industries, like real-estate, auto manufacturing and those with “One Belt One Road initiative” concept. These industries will have better than average growth and are now at historically low price-to-equity level.
Three things to watch in the near term: China may launch more easy monetary policies and fiscal measures. Policies may be unveiled in Beijing in early March, and we also could hear some details of the Shenzhen-Hong Kong stock connect scheme in the current quarter.
In terms of risks, we believe the A-share market is still a source of financial market turbulence. It will also impact MSCI China, which reflects performance of Chinese companies listed overseas. Meanwhile, concerns over the renminbi exchange rate will also be a drag on the stock market.
Thanks to ample liquidity, Chinese stocks will likely offer small returns for investors in the first half. We expect the increase in valuation multiplier to offset the impact of reduced corporate earnings.
This article appeared in the Hong Kong Economic Journal on Feb. 2.
Translation by Myssie You
[Chinese version 中文版]
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