Hang Seng suffers split personality
Yesterday, during intraday trading, the Hang Seng Index climbed to a record high. But it was a half-hearted sort of record, reflecting investors' ambivalent feelings towards the market.
The session started bullishly as investors shrugged off concerns about the US sub-prime mortgage market and pushed the Hang Seng to a new record high at 22,975.81. The buoyant mood did not last. Worries soon took over and the index dropped back to finish a shade below Tuesday's record close.
The market's schizophrenic performance illustrates neatly how investors are in two minds about the prospects for equities in the second half of the year.
Viewed from one angle, the outlook appears rosy. Although the Hang Seng has risen an impressive 170 per cent from its Sars-struck low in April 2003, valuations are relatively moderate by recent historical standards.
Priced at about 17 times earnings, the Hang Seng is valued well above the dismal days of early 2003, when it slumped to just 13 times earnings. On the other hand, valuations remain below those seen during the first part of the post-Sars rally, when they climbed above 20 times earnings. That implies they could go higher still from current levels.
It is true that H shares are valued a lot more richly at about 23 times earnings. But despite recent gains they remain at a substantial discount - typically between 20 and 60 per cent - below their mainland peers.
With some of the froth now blown off mainland markets by the recent retrenchment, it looks less likely that a mainland market crash will drag H-share prices lower. Equally, with the mainland authorities reluctant to stamp too hard on the mainland's economic brakes, growth in earnings derived from the mainland will remain strong. As fund flows from the mainland into the Hong Kong market increase over coming months with the extension of the qualified domestic institutional investor initiative, many investors are looking for Hong Kong stock prices to rise further.
Seen from another angle, however, things are looking increasingly ugly. Although the domestic liquidity which has helped keep the market afloat remains plentiful, it is not as abundant as a few months ago. The discount between Hong Kong and US dollar interest rates has narrowed 0.4 percentage point over the past six months.
At the same time overseas investors' appetite for Hong Kong stocks has abated, and international fund flows into the market have subsided and even reversed at times. With long-term interest rates up sharply, credit spreads widening in response to nerves over the sub-prime meltdown and the oil price up 45 per cent since January, the fear now is that the balance between fear and greed could reach a tipping point and that investors could develop a sudden aversion to risk.
That could prompt a rapid unwinding of carry trades, which have been rebuilt since March, and a wholesale retreat from assets perceived as relatively risky, including Hong Kong stocks. The market could easily drop by 10 per cent in a matter of days. No wonder investors are suffering from split personalities.