20 October 2019
US markets may climb to new highs next year, providing momentum to other bourses, including Hong Kong. Photo: Reuters
US markets may climb to new highs next year, providing momentum to other bourses, including Hong Kong. Photo: Reuters

2018 outlook: Equities to hit new high, property under pressure

After a strong rally this year, the Hang Seng Index is likely to sustain the strength and hit a record level in 2018.

Supporting the bullish outlook is the recovery momentum of the global economy and improving earnings.

The ratio of positive profit alerts and EPS forecasts for Hang Seng Index constituents have both trended upward of late.

Based on price earnings ratio and cyclically adjusted earnings, the potential gain of the benchmark index is about 23 percent, implying an upside target of around 36,000 points.

If valuations can go back to the top end (based on the average top price-earnings ratio seen during the previous eight bull cycles since 1980), the index could even reach 39,000 sometime next year.

HK housing market to underperform equities

Home prices, however, may not do as well as it’s widely expected that local banks may raise the prime rate next year. Initial impact could be mild, but there is a chance US interest rates could climb faster and more than expected as global inflation picks up.

The super rally of Hong Kong properties since the global financial crisis largely stemmed from quantitative easing by major central banks overseas and the subsequent influx of capital.

Enormous capital has flowed into Hong Kong since the 2008 financial crisis, and the city’s monetary base has expanded over 4 times, exceeding the corresponding growth in US during the same period.

But this key driver of the city’s skyrocketing home price is going to reverse. When that happens, it could lead to an extended period of property market correction.

US stocks to extend gains

The US market, meanwhile, may continue to extend the rally into next year. S&P 500, Dow Jones Industrial and Nasdaq indexes have generated a remarkable return of 22.1 percent, 28.3 percent and 30.8 percent respectively as of December 19. If macro economy sustains strong growth and corporates earnings continue to improve, US equities may set new record next year.

Currently, the cyclically adjusted price-to-earnings (CAPE) multiple of US market is at 32.44, close to the historical peak of 32.56 seen in 1929. However, the valuation still has some upside room due to earnings growth and asset rotation (investors moving out of bonds into stocks). Drawing inference from the peak CAPE levels seen before the market collapse in 1929 and 2000, there could be another 30 percent upside for US market.

Watch out for more volatility

That said, global markets have been addicted to monetary easing from central banks since the 2008 financial crisis. And various asset prices have surged or even become somewhat bubbly.

If another powerful stock rally materializes as expected, and interest rates keep going up, up to a certain point, lofty valuations could weigh on asset prices and put an abrupt end to the bull market during the latter part of 2018.

All in all, prices of various asset types may witness unprecedented volatility next year.

This article appeared in the Hong Kong Economic Journal on Dec 21

Translation by Julie Zhu

[Chinese version 中文版]

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Hong Kong Economic Journal chief economist and strategist