Valuations say buy, but the fearful doubt their validity

The recent wild volatility in the Hong Kong stock market (see the first chart below) reflects the current tug of war in investors' minds between greed and fear.

The greed element is simple enough. Most of the valuation measures investors habitually look at are telling them that Hong Kong-listed stocks are trading at bargain basement prices and that the market is a screaming buy - probably the best buying opportunity of the decade.

The fear factor is straightforward too. Investors are worried that the valuation measures they usually rely on simply don't work in exceptional times like these. The market might look cheap, but that doesn't necessarily rule out further abrupt falls in the near future.

The most commonly used valuation measure, the price to earnings ratio, certainly makes Hong Kong stocks look attractively priced. At just 8.2, the price to historical earnings ratio is cheaper than at any time since the depths of the Asian crisis in 1998.

Unfortunately, looking at past earnings is of limited use. Profits were generally strong last year, but with Hong Kong now in recession and the mainland's growth prospects deteriorating fast, last year's earnings performance is unlikely to be repeated any time soon.

As a result, investors are preferring to look at the ratio of stock prices to forecasts of future earnings. On this basis also, Hong Kong equities look attractive. At 9.8 times estimated earnings for this year and 9.3 times for next, on the face of it the market seems to be compelling value.