Morgan Stanley's 'bull tail' sees Hang Seng at 50,000

Scenario may sound unfeasible but the Hang Seng Index's 44-year history implies the chance it will make such a rapid gain is strong

PUBLISHED : Tuesday, 14 May, 2013, 12:00am
UPDATED : Tuesday, 14 May, 2013, 3:32am

Morgan Stanley's chief Asian equity strategist Jonathan Garner raised more than a few eyebrows yesterday among the 1,000 or so portfolio managers assembled in the ICC for the bank's Hong Kong investment conference.

He told them there is a "credible" chance that the city's benchmark Hang Seng index could reach the 50,000-point mark before the end of 2015.

With the index closing yesterday at 22,989.8 points, down 1.4 per cent from Friday, his scenario would deliver investors a return of 117.5 per cent in little more than 2-1/2 years.

That might sound unfeasibly bullish. But as Garner points out, in historical terms such an extended rally would be nothing out of the ordinary. Looking back over the Hang Seng's entire 44-year history implies the chance it will make such a rapid gain is as great as 1 in 3.

As the first chart below shows, the last occasion it did so was between October 2008 and April 2011, when the index rose by 121 per cent. Before that, between April 2005 and October 2007 it surged by 132 per cent.

Now, says Garner, the index may be primed for an equally spectacular rally over the next 2-1/2 years. Ignoring the market's inconvenient intermediate peak in 1997, he notes that cycles in the Hang Seng typically last around eight years, with a peak-to-peak gain of between 50 and 100 per cent. If the pattern repeats following 2007's record of 31,638, he reckons the market should top out in late 2015 somewhere close to 50,000.

The liquidity conditions look right. In the past, he notes that the Hong Kong market has peaked some three years after the US Federal Reserve began its latest round of easing, just as it starts to tighten once again.

Measuring from the beginning of the Fed's third round of quantitative easing last year, that would imply the Hong Kong market reaching a peak towards the end of 2015.

True, the stock market has been relatively slow to respond to easing this time around, but Garner argues the Hong Kong government's efforts to cool the city's property prices may now work in favour of an equity rally, diverting liquidity away from real estate and into stocks.

The valuations look attractive. As the second chart shows, on a price-to-book-value basis, the Hang Seng is currently trading towards the lower end of its long-term range at ratios that imply handsome price gains over the next two years.

What's more, Garner's bullish scenario echoes Monitor's own late 2011 analysis of the Hang Seng's cyclically adjusted price-earnings ratio and its dividend yield spread, both of which implied at least a doubling of prices over the coming earnings cycle.

And finally, there is a fund-flow argument why the Hang Seng may rally powerfully over the next couple of years.

If Beijing ever goes ahead with plans to open mainland markets to foreign investors, the re-weighting of institutional benchmarks to include the Shanghai and Shenzhen stock markets will trigger massive capital inflows, pushing mainland equity prices sharply higher. The resulting arbitrage opportunity will lift Hong Kong's market in its turn. And if mainland funds are allowed to flow offshore, the gains will be further amplified.

Before you get carried away, Garner does stress his 50,000 call is a "bull tail" scenario, with only an outside chance of being realised. But after the disappointments of the last few years, it's the sort of tale many investors are dying to hear.

Last week Monitor ridiculed talk that Beijing has a five-year timetable for liberalising interest rates and floating the yuan, noting that officials also had a five-year timetable back in 2000.

Well, former central bank staffer Joe Zhang has gone one better, pointing out that: "In the 1980s, the government made us believe that liberalisation of interest rates and, indeed, the yuan was only five years away. Those five years have never ended."