It has been a remarkable year for equity investors. Over the past 12 months, Hong Kong's benchmark Hang Seng Index has more than doubled in value.
But bullish investors hoping for similar gains over the next 12 months are likely to be disappointed. The rally of the past year is not going to be repeated any time soon.
Today marks the very bottom of the financial crisis for the Hong Kong stock market exactly 12 months ago. It was a Black Monday if ever there was one. The Hang Seng Index plunged a gut-wrenching 15.4 per cent from the previous close to hit a five-year low at 10,676 points, down a mind-boggling 66.6 per cent from the record high set just one year before.
Since then, the market has bounced back in fine style. At first, the rally was tentative. Although stocks were trading at bargain basement prices, many investors feared that the death-spiral sell-off had not finished and that the apparent recovery was a dead-cat bounce: a suckers' rally in a continuing bear market.
But when the Hang Seng Index failed to plumb new depths in March when United States equities hit their low, observers took the local market's resilience as a powerfully bullish signal.
Since then, global investors have poured hundreds of billions of Hong Kong dollars into stocks listed in the city, powering an impressive run-up in equity prices.
As a result, at Friday's close, the Hang Seng Index was quoted at 22,590 points, up a meaty 112 per cent from its crisis low point reached just 12 months earlier (see the first chart below).
Unfortunately, although sentiment remains bullish and inflows are still strong, investors getting into the market now are unlikely to earn returns anything like as generous as those enjoyed over recent months.
For one thing, Hong Kong stocks are no longer cheap. Whatever valuation measure you choose - price-earnings, price-book value or price-to-cash flow ratios - local shares now look decidedly pricey compared with other major markets.
And for another, the buying momentum is looking dangerously overstretched. To get an inkling why, take a look at the second chart below, which shows the Hang Seng's percentage deviation from its 200-day moving average over the past eight years. At the moment, the index is more than 30 per cent, or more than two standard deviations, above trend. As the chart makes clear, such big divergences are seldom maintained for long.
That doesn't necessarily mean the index is primed for a major sell-off, only that it will not continue rising at the same frantic pace over the coming months.
If an end to the run-up looks likely for technical reasons, it makes sense from a conceptual point of view, too.
There is a strong argument to be made that debt financing is going to be a lot scarcer after last year's crisis. As a result, if the next business cycle cannot be funded by debt, it is going to have to be financed largely by equity. That means equity will have to be attractively priced from the point of view of buyers, which rules out a return to the heady valuations of the last market rally.
The trend is already apparent, with the initial public offerings coming to the market at the moment priced at a steep discount to prevailing valuations in order to drum up investor interest.
In time, the new supply of cheap stock must weigh on secondary market prices, making further rapid gains increasingly unlikely.
So, although the past 12 months have been wonderful for investors brave enough to jump into the market near its lows, unfortunately, the next year is not going to be nearly so rewarding.