22 October 2016
The Hang Seng Index plunged on the first day of trading after the Lunar New Year holiday. Photo: HKEJ
The Hang Seng Index plunged on the first day of trading after the Lunar New Year holiday. Photo: HKEJ

Stock market falls amid deflation risk

Is deflation rearing its ugly head again in Hong Kong? 

Falling real estate and stock markets will put pressure on asset prices, but household income is another factor to watch.

The financial industry is having a hard time given the situation in the stock market, while the retail and tourism sectors are also being impacted by mainland China’s slowing growth.

The Port of Hong Kong has slipped to No. 5 on the list of the world’s busiest container ports in terms of container throughput.

The Hang Seng Index may stay below its 100-month average for a long time.

Aside from the deflation risk, central banks don’t have as many tools to stimulate the economy as they had during the 2008 financial crisis.

Valuation is a dynamic process. If the deflation expectation leads to a continuous decrease in corporate earnings, an eight times price to equity ratio doesn’t equal to “cheap”.

The HSI may drop by one-third more to reach its real bottom level.

The deflation risk is seen not only in Hong Kong and China, but all over the world. Just look at the impact of the plunging prices of oil and other commodities.

The oil price drop will affect not only oil stocks but also the shares of banks that have lent large amounts of money to energy companies.

And as oil companies and banks are heavily weighted in stock indexes, how can we expect the stock market to perform well?

The 10-year US Treasury note is currently offering a yield of 1.7 percent. Although the Federal Reserve is gradually raising interest rates, the bond’s yield is dropping instead of rising.

A high yield for bonds reflects high demand for money in the economy, and usually indicates good return from the stock market.

But with ample liquidity in the market, quality investment targets are limited. That US Treasury yields remain low means low investment return is now the “new normal”.

For those who have low exposure to the stock market and are still counting years before retirement, they don’t need to worry about the current volatility.

But for those about to retire or have a big exposure to the stock market, they should consider reducing the weight of stocks in their portfolio to less than 30 percent.

This article appeared in the Hong Kong Economic Journal on Feb. 12.

Translation by Myssie You

[Chinese version 中文版]

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Columnist at the Hong Kong Economic Journal

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