Chart 1: HSI has breached 20,000 points for the first time since September 2008!

Chart 2: A similar rebound in HSI after the Asian Financial Crisis (rebased at the market peak before the crisis)

In retrospect, we made a “Markets have bottomed” call for both Hong Kong (represented by the Hang Seng Index) and China H-Share (represented by the Hang Seng Mainland Composite Index) on 13 November 2008. We set our HSI target level for 2009 at 20,000 points. On the 27th of July 2009, the HSI closed at 20,251 points, which was the first time for the index to close above 20,000 points since September 2008. Chart 1 shows the performance of the HSI index since October 2007.

As the HSI reached our 2009 target level of 20,000 points, we expect that investors who followed our call will now face the dilemma of “to buy or not to buy”. Although the current investment sentiment is improving significantly, our estimation for the HSI in 2009 remains at the 20,000 point level. The unchanged target price does not mean that we are bearish towards the Hong Kong market. We believe that in terms of valuation, HSI is now trading at a reasonable PE level.

The Current Rally: A Result of Excess Liquidity

Investors tend to be either over optimistic or over pessimistic. Not long ago, we have seen a panic selling in October 2008. A single digit PE is considered as unattractive for most investors at that moment. Today, investor’s investment sentiment has certainly been improved and they are now more willing to invest.

Positive news of the Hong Kong stock market is being reported every day. For example, excess liquidity is flowing into Hong Kong and giving support to the stock market. According to the Hong Kong Monetary Authority, they have recently injected HKD1.938 billion (US250 million) into the money market in New York trading to stem an appreciating Hong Kong dollar (as excess liquidity flows into Hong Kong and pushes up the demand of Hong Kong Dollar) and keep it within its fixed trading band. Hence, the injection has lifted the aggregate balance, which is the sum of balances on clearing accounts maintained by banks with the HKMA, to HK$216.031 billion by 30 July.

Excess liquidity is one of the reasons that drove up the HSI. The higher the HK aggregate balance, the more the excess liquidity, and more support to the stock market. However, investor should note that excess liquidity flow is highly liquid. The strong inflow we saw in July might turn into a huge outflow in August. As a result, the risk of investing into the stock market by following the liquidity is relatively higher. Therefore, we suggest investor go back to the basics, that is, fundamental analysis.

Better Earnings Expected For 2009 and 2010

In terms of valuation, the current consensus forecast of HSI earnings growth for 2009 and 2010 is 3.9% and 18.5% respectively. Hence, as of 28 July 2009, the estimated PE level of HSI for 2009 and 2010 is correspondingly at 19.3X and 16.3X.

From our past experience, most analysts would make the right call when the economy is on a steady uptrend or downturn. When the economy takes a sudden turn (e.g. after the subprime crisis in 2008) and earnings become very difficult to predict, the consensus analysts’ forecasts tend to be less accurate. Therefore, we believe that the earnings growth for 2009 and 2010 is likely to be underestimated. We expect that in the next 6 to 12 months, positive news will increase and dominate the market. Earnings forecast will continue to revise upwards and this will ensure the sustainable recoveries in the stock markets.

Sustainable Market Recovery Is In Sight

During the Asian Financial Crisis, Asian economies were hit hard by global speculators. Many Asian countries were hurt by currency depreciation, high external debt and limited international reserve.

The Hong Kong dollar has also faced speculative pressure as the Hong Kong dollar is pegged to the US dollar. Hong Kong Monetary Authority has spent more than US$1 billion to defend the local currency. At the same time, the Hong Kong stock market dropped more than 20% within 3 trading days in late October 2008.

Sounds dreadfully familiar? Chart 2 shows a rebased chart of the HSI performance during the Asian Financial Crisis and the Subprime Crisis. From the chart, we find that the magnitudes of both corrections are similar, but the market took a longer time to recover in the subprime crisis this time round.

According to the chart, the shape of the current market rally is similar to early 1999. We are confident that the HSI is likely to follow the recovery path as seen in 1999. Hence, investors are recommended to invest now and hold for at least one year in order to capture the upside during the stock market recovery. We do agree that corrections will be seen from time to time, but in general, the market is gaining its upward momentum. Amidst the volatility in the coming 6 to 12 months, we believe there will also be plenty of investment opportunities.

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