Conclusion: We are sticking to our guns on the short side of Hong Kong equities.
Late last Friday, we shorted Hong Kong equities in our Virtual Portfolio; this is consistent with the research view we’ve held since 2Q. On May 24th, we formalized our bearish research view of Hong Kong equities in a lengthy note titled, “Hong Kong Is Not Mainland China” (email us if you’d like a copy of the report). The conclusion of the note was as follows:
“The combination of slowing growth, accelerating inflation, and a property bubble that will either pop or continue to be addressed from a policy perspective has us bearish on Hong Kong equities over the intermediate-term TREND.”
That thesis is largely still intact, with the exception that we believe Hong Kong inflation has already peaked for the current cycle – largely due to a +7.9% YoY pop experienced in July as a result of a property subsidy in July ’10. Without such on-off factors, inflation in Hong Kong would have accelerated to +6.3% YoY in July and has since slowed to +5.7% YoY in August. While slowing inflation might prove bullish for most economies in the sense that they can cut interest rates, Hong Kong is in “the box”, with rates already near ZERO percent due to the currency peg with the USD:
Even though we expect Hong Kong CPI to continue trending down over the intermediate term, we expect it to remain as sticky as any CPI readings globally form an absolute perspective, given that inflation in Hong Kong is largely being perpetuated by a property price bubble. Hong Kong property prices, up +71% since the start of ’09 and +2.1% above the prior leverage cycle peak just before the Asian Financial crisis (per Centaline Property Agency data), have been driven higher largely by an influx of mainland Chinese buyers looking for healthy inflation adjusted returns amid a crackdown on domestic property speculation. Additionally, the yuan’s +7.2% increase vs. the Hong Kong dollar over time period has indeed made Hong Kong property cheap on an FX-adjusted basis. Burgeoning retail rents (up +27% since the start of ’09, per Collier International) are contributing to supply-side price pressures that we don’t see easing absent a bursting of the world’s most expensive property market – per a recent study by Demographia International that ranks Hong Kong dead last among 325 global property markets with a median house price at 11.4x gross annual median income (nearly double that of New York City’s 6.1x ratio!).
Now Hong Kong is in a catch-22 scenario, whereby a property bust could spell disaster for the Hong Kong banking system or allowing the “fun” to continue and put pressure on consumer price inflation – risking an acceleration of this year’s well-attended protests as consumers become increasingly disgruntled with prices as wage growth slows due to waning economic growth. It’s worth highlighting that Hong Kong is among the world’s most sensitive economies to the global economic cycle (exports > 200% of GDP) – a cycle we’ve been appropriately bearish on YTD and continue to be bearish on for the intermediate-term TREND. Manufacturing growth is slowing; export growth is slowing; and the trade balance is compressing at an accelerating rate on a YoY basis:
A 13yr-low in unemployment (3.2% in Aug) will keep the wheels from completely falling off of the economy, but this story isn’t about consumer demand. No, it’s more about a government that is in “the box” from a policy perspective and must sit idly by as the global economy dictates its growth rate. As such, we anticipate that lower-lows are more than likely on the horizon for Hong Kong economic growth over the intermediate term.