Hong Kong equities outlook healthy, say analysts

Analysts are positive about the outlook for Hong Kong equities despite differing views on the odds of a US recession and concerns about growth in China.
Last week the Hang Seng Index experienced its worst plunge since the terrorist attacks of September 11, 2001, driven by questions about the future of the China growth story and nervousness regarding the likelihood of a recession in the US. However, a number of brokerages remain optimistic that Hong Kong equities could still be an attractive story.

The Hang Seng Index shed more than 5.6% or 1,386 points on Wednesday, after the US markets lost 2.2% the night before. The DowÆs fall was led by Citi which was hammered on the announcement of its fourth-quarter losses and an $18.1 billion write-down owing to subprime woes.

The Hong Kong market recovered on Thursday in anticipation of good tidings from Federal Reserve chairman Ben Bernanke. However, the good tidings were not forthcoming and further bad subprime news from Merrill Lynch shook investor confidence again. The Hong Kong market closed at 25,201 on Friday, marginally up 0.35%.

There is also no agreement about how dire the situation really is in the US. A Morgan Stanley research report dated January 16 suggests the local economy in the US remains resilient and a recession is not a problem.

But Barclays' head of emerging Asia rates research, Peter Redward, was more guarded in a presentation last Friday. ôAt this stage the US wonÆt slide into a recession, but we will see subdued growth in the first half of the year, at around 1% to 2% quarter-on-quarter, so very soft growth. It is possible for the US to experience negative growth for a quarter,ö he says.

RedwardÆs outlook is similar to that of Goldman Sachs which predicts, in a report dated January 14, that a mild recession could strike the US this year with GDP falling at an annualised one percentage point in the second and third quarters.

A Merrill Lynch analysis of the latest US employment data indicates a recession could have already arrived. In December, the jobless rate in the US hit 5%, against the 4.4% trough in March. A Merrill report dated January 7 finds that over the past 60 years, the US economy slipped into recession every single time the unemployment rate surged 60 basis points from the cycle low. Other US employment indicators such as the unemployment rate and household employment corroborate this view.

Based on technical analysis the US equity market is priced one-third of the way for a recession.

In addition to fears regarding the US economy, China-specific factors are also cause for concern. Investors are increasingly uncomfortable with a potential slowdown of exports, rising inflation risks and aggressive monetary tightening policies in China. Last December the PeopleÆs Bank of China (PBOC) announced an interest rate hike that lifted the one-year base deposit rate by 27bp and lending rates by 18bp. At the same time the PBOC, along with the China Banking Regulatory Commission, introduced new tightening measures with respect to purchases of second homes in an effort to control real estate prices.

Against this backdrop, the general view is that markets globally will remain volatile in the short term. But specialists are optimistic about the medium- to long-term prospects for Hong Kong equities.

ôI think it is unlikely the Hong Kong equity market will rally in the face of falling equity markets globally,ö says Redward at Barclays. ôBut the Hang Seng Index is in a good position to weather the storm.ö Redward suggests Hong Kong benefits from being well integrated with the Pearl River Delta, the fastest growing region in the world, and that companies in Hong Kong have managed risks well and therefore are in good shape with strong earnings growth.

ôThe fundamental strength of the economy and the fundamental strength of corporate balance sheets suggest we will see a rebound, and we should probably see a strong rally in the Hang Seng Index,ö Redward continues, although he believes a rebound is more likely in the second half of the year.

In its regional portfolio, Merrill Lynch is the most overweight Hong Kong and is in agreement with some of RedwardÆs points

Morgan Stanley upgraded its Hong Kong market outlook to 'In-Line' from 'Cautious' on Wednesday, the same day the market tumbled. The US bank reminded investors that the Hang Seng Index has already fallen to slightly below its fair value.

Morgan StanleyÆs research noted that the market correction was primarily attributable to run-ups in valuations. The bank says that given strong liquidity inflow and supportive government measures, the economy is still on a healthy path. It projects that the Hong Kong and China economies will grow 5.8% and 10% respectively in terms of real GDP in the current year, and forecasts the Hang Seng Index will reach 30,000 -- 22% above the current level -- by the end of 2008. It advises investors to start buying selectively.

Specialists may not be able to reach a consensus on the likelihood of a US recession but on Hong Kong's equity markets there seems to be more agreement. For investors with the ability to stomach volatility, it would seem that Hong Kong equities could provide a good opportunity to invest some money.
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