23 October 2018
Liquidity inflow has become a major driving force amid an upbeat market sentiment. Photo: HKEJ
Liquidity inflow has become a major driving force amid an upbeat market sentiment. Photo: HKEJ

Southbound capital inflow may not dominate bull cycle

The Hong Kong market has outperformed so far this year. I’m conservatively positive on that, since I don’t think Hong Kong will fully benefit from China’s capital outflow.

Hong Kong equities are just one of the investment targets for mainland investors, but not the only one. Therefore, we should consider Hong Kong as a detour for mainland capital.

A typical, multi-year bull market consists of three stages. The first stage is the recovery from crazy bear market lows. Investors have usually lost confidence in the market and dumped all stocks regardless of losses. In fact, that’s the best timing to enter the market. Investors with good vision would start to buy with price limit and accumulate gradually in light of improving market conditions such as an uptick in market turnover.

Most stocks will change hands to this group of visionary investors. That marks the end of the bear market cycle and the beginning of the bull market.

Steady market gains lure new investors, which usually leads to rising market trading. Good news flows are emerging, as corporate earnings have improved.

The second stage is steady improvement, in gear with a general improvement in the economy. Stock prices may consolidate after hitting a certain level, while overall market sentiment remains upbeat. The market has shown signs of moving sideways.

The third stage is the speculative one, when newcomers pour into the market and buy because “everything is going up”. As a result, market turnover has kept increasing, and each market correction has drawn even more investors. The whole market is in a hype mode and dominates newspaper headlines.

Besides, there are steady flows of good news, such as doubling earnings and M&A deals. And listed companies are very active in the capital market. That marks the end of the bull cycle and strong speculative sentiment. Junk and little-known stocks have posted soaring prices, as well as companies which don’t pay dividend for a long time or have financial problems. By contrast, investors have shunned good stocks with strong fundamentals. If the situation reaches an inflection point, a market crash occurs.

It seems that the Hong Kong market still has strong upward momentum and already got rid of the curse of the market fall in July. However, investors should bear in mind that the US Federal Reserve will shrink its balance sheet later this year, although it has slowed the pace of hiking rates. In the meantime, China may tighten liquidity in order to stabilize the financial market.

Liquidity inflow has become a major driving force amid an upbeat market sentiment. The market has high expectations for southbound inflows. Capital inflow and daily market turnover are key indicators to judge the sustainability of the bull cycle.

Currently, China’s economic growth and liquidity have shown mixed signs. That will accelerate the consolidation of various industries. It would benefit industry leaders, in particular those in cyclical and financial sectors. The heavyweights of the Hang Seng Index and China Enterprise Index are all industry leaders, which will benefit from industry consolidation and industry upgrade. And financial and cyclical stocks will also underpin the performance of the China Enterprise Index.

Also, foreign investors will have more confidence in the Hong Kong market. Foreign capital inflow might be critical to sustain the bull market. Southbound capital inflow may only be one of the support factors rather than a dominant force in the bull cycle.

This article appeared in the Hong Kong Economic Journal on July 31.

Translation by Julie Zhu

[Chinese version 中文版]

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Senior investment banker

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