Date
18 December 2017
Based on the monthly volatility pattern and overbought conditions of Hong Kong equities, another round of rally may be brewing. Photo: Reuters
Based on the monthly volatility pattern and overbought conditions of Hong Kong equities, another round of rally may be brewing. Photo: Reuters

HK equities: The biggest surge is yet to come

The Hang Seng Index rallied 646 points or 2.37 percent in August, marking the eighth straight month-on-month gain.

The index has soared nearly 6,000 points or 27 percent over the period, a long winning streak that is quite rare.

Can this offer any insight into the market trend going forward?

Such an extended rally has only happened seven times since 1970.

In terms of short-term direction, historical patterns suggest that the rally may take a pause either this month or next month. Data over the last four decades shows that Hang Seng Index usually underperforms in September.

What about the longer-term outlook?

We can make an educated guess by looking at two barometers, one is the monthly volatility and the other is the overbought conditions.

A sustained rally usually attracts continuous buying. Will that exhaust the buying power and lead to a sharp decline afterwards?

Past records show that if the monthly volatility starts to pick up rapidly as stocks surge, the market will soon run out of steam and the Hang Seng Index usually goes into a deep correction phase.

For example, the Hang Seng Index rallied for eight straight months in 1978 and 2007, and gained for six months in 1972. The monthly volatility reached 18 percent, 20.3 percent and 67.4 percent respectively in those three periods. And the monthly volatility remained at double-digits before the uptrend came to an end.

In all three cases, the Hang Seng Index plunged in the following year.

But this time around, the benchmark gauge saw record low monthly volatility in June. The monthly volatility dropped to 5.3 percent on average in the last eight months, the lowest among all bull cycles in history.

Such low volatility indicates there is a good chance the market will take a brief pause and then embark on another round of rally.

So we could see a huge rally next year.

The Hang Seng Index is typically overbought after a long rally. During the bull cycles in 2007 and 2003, for example, it exceeded the 200-day moving average by up to 42.8 percent and 27.1 percent respectively.

By contrast, the index only exceeded the 200-day moving average by 1.2 percent at the beginning of the current cycle. During the eight-month rally, it was at most 15.1 percent above its 200-day moving average, the lowest among all previous cycles.

As such, the Hang Seng Index cannot yet be considered seriously overbought.

Various technical indicators show the Hong Kong market may see a strong boom next year.

This article appeared in the Hong Kong Economic Journal on Sept. 6

Translation by Julie Zhu

[Chinese version 中文版]

– Contact us at [email protected]

RT/CG

Hong Kong Economic Journal chief economist and strategist

EJI Weekly Newsletter

Please click here to unsubscribe