Alicia García Herrero (Natixis) | Although the chorus of voices saying Hong Kong stocks would bottom out grew louder in the last few months of 2021, we held the view that policy risk could linger for further underperformance. Indeed, the Hang Seng Index ended the year with -14%, which was a clear divergence versus other major markets. The question now is whether this gloomy picture on Hong Kong equities might continue in 2022. Our take is the pressure is probably here to stay, at least for the first half of the year.
First of all, Hong Kong’s stock market has the weakest sentiment in Asia. The number of declining shares remains elevated at around 60%. Experiencing capital outflows in equities, the USDHKD has turned weaker towards the middle of its trading band at 7.80.
Without fundamental changes in the three key policy risk factors, the pressure on Hong Kong equities will not fade. First, the growing importance of internet platform shares remain a double-edged sword. Although IPO activities have flourished thanks to Chinese tech firms departing from the US, the sector as a whole is still facing tough headwinds from regulations, such as tougher anti-trust rules, common prosperity and stricter data control. Second, Chinese real estate developers are fighting for survival in front of the “three-red-line” policy, leading to credit polarization. That said, delays in repayment and bond defaults may lift credit risks. Third, the geopolitical tension between the US and China continues unabated with a growing number of sanctioned companies in which US investors cannot invest and export controls.
As such, it is not a question of whether Hong Kong equities are cheap enough as prices can always go lower, but when the regulatory uncertainties can be cleared up, at least partially. There are a few signs that we can observe for the turnaround. Above all, investors will need to see the bottom line of the evolving regulatory changes with milestone events, such as a clearer path and resumption of IPOs by internet platforms (e.g., Ant Group), more cohesive effort to consolidate real estate developers and absorb the credit risk, and possibly an improvement in the US-China relationship. In terms of capital flows, the USDHKD should get stronger than the current 7.80 level as a sign that there are capital inflows interested in Hong Kong equities. Finally, an improvement in market sentiment should be seen.
In conclusion, Hong Kong’s equity market can still get worse before it gets better unless we see major changes in the current policy risk factors. Investors have been busy rewriting the growth story of different sectors under the new regulatory normal, but the process is still on the way. For China-related investment, the onshore market is a preferable venue with more diverse and regulatory neutral sector composition. All in all, more patience may be needed before we see a reversal in Hong Kong’s poor equity performance in 2021.