24 February 2019
Hong Kong equities could scale new peaks if China makes good progress in its economic restructuring attempts. Photo: Reuters
Hong Kong equities could scale new peaks if China makes good progress in its economic restructuring attempts. Photo: Reuters

The bull run may be just getting started

I had earlier set a two-year target for Hong Kong’s benchmark index at 40,000, with the forecast resting on the assumption that China will succeed in its economic restructuring attempt. Some of my friends in mainland China were skeptical, telling me that they don’t believe the market bull-run won’t sustain for so long, given their experience back home where “crazy bull markets” lasted 9 months on average.

Meanwhile in Hong Kong, some observers are still pessimistic about the prospects for the local economy and shake their heads in disbelief at my 40,000-level target for the Hang Seng Index. However, there are others who are turning more bullish on the stock market’s prospects, saying the index could reach the 40K level early next year.

After a retreat in July, the Hang Seng Index resumed its uptrend before China’s big four state-owned banks announced improved first-half profits. While the benchmark eased a bit after the results announcements due to the ‘sell on news’ factor, it looks set to edge up at the moment.

Let me go into some detail. I believe we had a 50 to 60 percent chance of seeing a healthy ‘slow bull’ market, taking the index to 40,000 level over a two-year period. In the scenario, we will see a 10 percent annual growth in earnings of the index constituent companies, and the benchmark will still be trading at PE ratio of around 15, probably lower than that of the S&P 500 index and the MSCI EM index.

Further, given that China’s economic restructuring is on the right track, the loan growth in the country will be under control, and banks will likely secure higher valuations. The price-to-book ratio of China Construction Bank will go up to 1.2, while that of Bank of China will reach 1.

Correspondingly, there is a 20 to 30 percent chance that Hang Seng Index will miss the target if China fails in its economic restructuring.

In July, China’s steel production rebounded to challenge its historic peak. Coal production reversed into growth after the capacity cuts, with precious metals getting into a bull market. For the economy to grow at a healthy pace, too much is as bad as not enough.

Moreover, rather than allowing the market to adjust towards efficiency, China has been using its visible hand in order to ensure the supply-side reform runs smooth, posing a threat to the long-term outcome. And we have not seen any ‘demand-side reform’ such as corporate tax cuts and value-added tax reduction, measures which I feel are needed to stimulate domestic consumption.

From my point of view, a painful economic restructuring may not spark a stock market crash. Instead, what I worry most about is that the slow bull market in Hong Kong stocks based on healthy pricing turns into a crazy bull market based on speculation and bubbles. Imagine a situation where the Hang Seng Index jumps to 40,000 level early next year, and shoots up further to 60,000 in the following year. In this scenario, the Chinese stock market may also get pushed up, forming a huge bubble. I would say, we have a 20 to 30 percent chance of seeing a crazy bull market.

Foreign banks and investors are playing a noticeable role at the moment. Early this year, Morgan Stanley released a report outlining its bullish stance on China’s long-term economic outlook. The US investment bank believes China will avoid the ‘middle-income trap’ in ten years with per capita income expected to pass US$13,000.

Morgan Stanley’s bullish outlook on China was later followed by similar views from Goldman Sachs and other major investment banks.

While China market will continue to remain vague and mysterious to foreign institutions, their abrupt change in stance raises a red flag to me. As I said before, I suspect the Asian financial crisis in 1997 was deliberately brought on by western powers. Are they making another attempt 20 years later?

In one brilliant move, foreign capital could tout the China market for its promising prospect and ignite investors’ interest. The excitement in the market, coupled with the weak dollar, would draw massive capital inflow to China. And then we would likely see an unprecedented, enormous bubble pop up, followed by a sudden burst.

China is at a critical juncture in its economic transition, and a crisis in the financial market would be catastrophic to its economy, dragging the country from breaking through the middle-income trap for a few years, at the very least.

All this said, I still believe the Hong Kong stock market’s prospects are good for two years. The benchmark has a 70-80 percent chance of reaching the 40,000 level, and possibly scale even higher peaks after a two-year period. 

This article appeared in the Hong Kong Economic Journal on Sept. 19

Translation by Ben Ng

[Chinese version 中文版]

– Contact us at [email protected]


Eddie Tam is the founder and CEO of Central Asset Investments.

EJI Weekly Newsletter

Please click here to unsubscribe