Yesterday's 6.4 per cent jump in the Hang Seng Index owes a lot to the 4 per cent rebound in United States stocks over Friday and Monday while the local market was closed. But although Wall Street's rise might have been the immediate driver of yesterday's bounce, the rally was underpinned by a strengthening belief among investors that Hong Kong stocks - and to a lesser extent their mainland counterparts - have been sold down too far, and that they now look like an attractive bargain.
That confidence has taken a long time to begin to return. Between October 30, when the Hang Seng topped out at a record high of 31,638, and last Thursday, Hong Kong's blue-chip index tumbled 10,553 points. That is a fall of one-third in less than five months: a vicious bear market by anyone's standards.
For the stocks of mainland companies listed in Hong Kong, the fall was even more severe. Over the same period the H-share index dropped 47 per cent, an even deeper drop than the 41 per cent slide in Shanghai A shares since mid-October.
The causes of the sell-off are simple enough. After last year's run-up, which saw the Hang Seng surge more than 50 per cent in two months and H shares almost double, valuations clearly looked expensive. As expectations declined that Beijing's 'through train' investment scheme would support prices, and fears grew that global trade would slow because of the US subprime crisis, investors began bailing out of the market.
According to EPFR Global, which monitors fund flows, investors have pulled US$16 billion out of Asia (ex-Japan) and Greater China stock funds this year, on top of heavy outflows in the last two months of 2007. Similarly, mainland investors concerned at the impact on share prices of rising inflation and interest rates have fled the domestic markets. According to official data almost two million investors closed their stock trading accounts in January and February.
But sliding prices have done a lot to restore valuations. At last Thursday's close, the Hang Seng was trading on a price-to-forward earnings ratio of just 14.2. That is below the index's average valuation since 2000 of 16.5, and looks enticingly cheap compared with October's high of 24.5. H shares look even cheaper.
With confidence growing that action by the US authorities will be able to put a floor under Wall Street's plunge, and brokers still forecasting earnings per share growth for the Hang Seng in the mid-double digits, Hong Kong stocks are beginning to look attractive again. And when you consider the index offers a dividend yield of 3 per cent while deposit accounts offer nothing, it is not surprising investors are getting back into the market.
Mainland shares are also looking more interesting. Although valuations of 30 to 40 times earnings are sky-high by international standards, they have fallen by half in recent months. And with investors increasingly concluding that Beijing is unwilling to aggressively jack up interest rates to combat inflation, prospects for earnings growth appear robust.
None of this means stocks cannot fall further in the near term, but it does look as if the tide of bearish sentiment may at last be beginning to turn.