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PUBLISHED : Wednesday, 09 January, 2013, 12:00am
UPDATED : Wednesday, 09 January, 2013, 3:38am

How to make money in 2013: just go with the liquidity flow

With lots of cash sloshing around, further gains are expected in the Hong Kong and mainland stock markets in the coming year

What would you like to read about in the paper?" I asked my esteemed colleague Lai See the other day.

"How to make money this year," came his curt reply.

Of course, how to make money in 2013 is what everyone wants to know. Happily there are a few pointers out there.

The first place to look is the Hong Kong stock market. After the benchmark Hang Seng Index turned in a highly respectable performance in 2012, some readers may be wondering whether the bull run has much further to go while global economic conditions remain so tricky.

They shouldn't be too discouraged. Yes, trading is likely to be choppy, especially during the first quarter as sentiment towards global equities is whipsawed by investors' hopes and fears over US fiscal negotiations.

But as in the second half of last year, the main driver of the Hong Kong market's performance in 2013 is likely to be liquidity.

Since last summer, when expectations of a fresh round of quantitative easing by the US Federal Reserve began to mount, capital inflows have boosted Hong Kong's monetary base by HK$130 billion.

On top of that, Denise Yam at Morgan Stanley estimates that between July and November, local banks absorbed a further HK$147 billion of capital inflows on to their balance sheets.

That means Hong Kong's total liquidity stock has been pumped up by at least HK$277 billion. With a good proportion of that money flowing into the stock market, it is hardly surprising that the HSI has shot up 20 per cent over the past six months.

With the Fed continuing to print money, and with Hong Kong still seen as both an island of tranquillity in a stormy world and as a play on recovery in China's growth, the liquidity should keep on pouring into the city's markets.

As a result, analysts expect gains of at least another 10 per cent from the benchmark index this year.

Liquidity is likely to prove the key driver of mainland stock market performance, too.

After a dismal start to 2012, mainland stock prices suddenly bounced in the last weeks of the year, with the Shanghai A-Share Index shooting up 16 per cent since early December (see the first chart).

Most analysts have attributed the rally to stronger expectations of economic reform and fiscal stimulus following the mainland's leadership transition.

But mainland stock markets are driven above all by the amount of excess liquidity washing around the economy.

When there is a lot of surplus cash around, it flows into the stock market, driving up prices. And when money is tight, stock prices fall.

You can see the relationship at work in the second chart. The black line represents the amount of excess liquidity in China's economy, measured as the ratio of narrow money-supply growth to the growth in nominal gross domestic product. The blue line shows the year-on-year performance of the Shanghai A-Share Index.

When the authorities massively boosted money supply in 2009 to stimulate the economy, within a few months, a lot of the spare cash found its way into the equity market, igniting a spectacular boom in stock prices.

And when Beijing slammed on the brakes in 2010, bringing the rate of money-supply growth below nominal output growth, stock prices soon began to sink.

Following last year's monetary easing, however, the amount of surplus liquidity in the system began to pick up again, and the stock market's downward trend duly slowed.

Excess liquidity figures can only be charted to the end of September, but if figures for the fourth quarter show the surplus cash in the system continuing to climb, it will be a clear hint that the recovery in the A-share market is likely to continue.

So there you have it: if you want to make money in 2013, surf the liquidity flows.

tom.holland@scmp.com

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Michael Lee
My plan to make money in 2013:
Work harder. Work smarter.
Inspire my employees to design, engineer and build great products to dazzle my clients.
I'll leave the speculation to the geniuses.

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