Properties keep grip on historic realities

PUBLISHED : Tuesday, 16 June, 1998, 12:00am
UPDATED : Tuesday, 16 June, 1998, 12:00am

My, it's lonely being an optimist on Hong Kong in these gloomy times.

Today, another argument on why the yield structure says the market is cheap. It won't make much difference until senior government officials realise that they do not have the engineering expertise to tinker with the wheels of this economy, but it will certainly set them moving once they stop their tinkering.

Look at my first chart. It shows that the trend of property yields in Hong Kong bears a close correlation to the trend of US short-term interest rates.

US interest rates went sharply down in 1991-93, as the financial community grew satisfied that disinflation had come to stay.

Hong Kong property yields were dragged along through the currency link to the US dollar.

For many years, those property yields had stood at 9 to 10 per cent, a reflection of Hong Kong's previously high inflation rate. We can now safely put a figure of 5 to 7 per cent in the equation as long as US interest rates remain low, and I think there is little danger of much higher rates here.

There is still volatility in the property yields. They went down below 4 per cent in the middle of last year, with an enormous influx of money from China. They are now rising again, but this is in reaction to an unsustainable low as well as to Hong Kong's present troubles.

Now look at those property yields relative to the earnings yield of the stock market (earnings as a percentage of price rather than the PE ratio of price divided by earnings).

Again this shows a correlation, which is not surprising given that Hong Kong's stock market is property dominated. The earnings yield is almost always higher, because investors demand a discount when buying property through the secondary means of the stock market. If the returns are the same or even within 1 per cent, they tend to buy the property directly and sell the stock.

This shows up clearly in the stock-market corrections of 1987, 1989, 1990 and 1993. On all those occasions, the earnings yield shot up again as share prices fell. But the yield gap between stocks and property was never even close to 1 per cent over the last two years and so the normal trigger for a stock market correction against property was never present.

Even assuming that property yields have now risen to 6.5 per cent (with prices moving so fast it is almost impossible to measure at present), the yield gap would be higher than at any other time over the period of the chart.

In other words, the property market is still showing the effects of the linkage to the US dollar but the stock market, always more volatile, is not.

I'll side with the steadier of these two indicators.

The stock market may have temporarily forgotten that the Hong Kong dollar is just a US dollar of another colour, but that does not change the facts as long as the currency link holds, and I think it will.

All we need now is the Government to let the market run itself.