Following a slide last week on US-North Korea tensions, most stock markets in Asia rebounded on Monday. But don’t get over-excited by that. A correction in equity prices is overdue, and I expect downward pressures to last a while. Here are four reasons:
1. Geopolitical risks escalating
The US and Japan kicked off a joint military exercise on August 10, and the US-South Korean joint military drills are due to begin later this month, exacerbating tensions in the region.
Meanwhile, China and India continues to face off over the Doklam Plateau. The patriotic tone of China’s highest-grossing blockbuster movie, Wolf Warrior II, has been widely shared by Chinese netizens amid the border dispute with India, threatening the latter with military retribution, while India also seems to be gearing up for a war.
Though an armed conflict seems a possibility, almost everyone thinks that a full-scale war will not happen. However, I am worried that if the conflict turns into a military one, it will completely knock off lasting peace in Asia-Pacific region.
2. Bearish warning signals in US stock market
A host of iconic investors on Wall Street, names such as Oaktree Capital founder Howard Marks, DoubleLine Capital CEO and bond guru Jeff Gundlach, openly warned that stocks (and bonds) are overvalued, especially several tech stocks. It is worth noting that Marks also criticizes the US$100-billion SoftBank fund. He said the willingness of investors to invest in the fund for levered tech investing “is a further indication of an exuberant, unquestioning market”.
3. US Fed set to begin balance-sheet unwind in September
The long-anticipated reduction of the Fed balance sheet will happen in a gradual manner. Traders have been bracing for a start of the unwind featuring offloading of up to US$6 billion in government bonds and US$4 billion in mortgage-backed securities each month, and gradually raising the cap.
It probably won’t have a big impact on financial markets, but as the quantitative tightening looms for the first time in history, investors really need to watch out for a butterfly effect in the market. As Fed chair Janet Yellen and ECB President Mario Draghi will speak at the Fed’s Jackson Hole symposium in late August, we can look for further signals regarding the policy stance of the Fed and other central banks.
4. China’s economic deleveraging and restructuring
On Monday, China reported industrial output, retails sales and fixed-asset investment figures for the month of July, and the figures all missed expectations. Housing price growth slowed, and exports and imports were weaker than expected as well.
I believe slower growth would be good for China, but the key issue is the progress of deleveraging and economic restructuring efforts. As for now, authorities have not been aggressive enough in promoting deleveraging.
Amid the current situation, I expect a correction in the US stock market over 2 to 3 months, or even longer. But the pullback would be gentle, possibly less than 5 percent.
If that’s the case, the potential downside risk for Hong Kong stocks is not too much. Strong buying interest of foreign and mainland China funds will help support the Hong Kong market.
China’s stock market remains strong and unaffected by the global currents. The Shenzhen Composite Index rebounded around 2 percent on Monday.
Given these factors, I believe any potential correction of Hong Kong stocks will last just one to two months.
I had outlined a 26,000 target for the benchmark Hang Seng Index early this year. As the index breached the target level in July, many market observers started to aggressively aim at 28,000 to 30,000 or even higher for the benchmark this year. As for me, I have no intention to raise my target.
I hope the Hong Kong stock market won’t be driven to crazy heights. The ideal case will be the benchmark index staying below the 29,000 level this year. In that scenario, the market will be trading at PE ratio of 13.
If listed companies’ grow their profits by double digits in the next two years, the benchmark index could reach the 40,000 level after that period.
It may sound crazy, but in that case, the Hang Seng Index will still be trading at PE ratio of barely 16. The average PE ratio of the index in the past 20 years was just 12 and peaked at 19.
If China’s economic restructuring succeeds, the valuation of Hong Kong’s benchmark index is likely to rise, and the 40,000 target can be realized.
This article appeared in the Hong Kong Economic Journal on Aug. 15
Translation by Ben Ng
[Chinese version 中文版]
– Contact us at [email protected]