Few in finance have memories of the markets that stretch back 30 years. But those whose recall does extend back to the mid-1980s could be forgiven for feeling a little nervous as Hong Kong enters the second half of 2017. The latter months of years that end in a seven are seldom lucky for investors in Hong Kong assets.
Consider 1987. The October 1987 crash hit stock markets around the world, but Hong Kong was hammered especially hard. On Monday, October 19, the city’s benchmark Hang Seng index fell 11 per cent, a slump that prompted stock exchange chairman Ronald Li to suspend trading for the rest of the week “to protect the investor”.
It was suggested at the time that the investor Li was most concerned about was himself. If so, his suspension did not have the desired effect. With trading on the Hong Kong Futures Exchange also halted and dealers facing heavy margin calls on their positions, many defaulted, triggering the collapse of the exchange’s clearing house and forcing a government-backed bail-out. When trading finally resumed a week late, the Hang Seng plunged a further 33 per cent.
Today the crash is possibly best remembered for how Li publically threatened the Hong Kong correspondent of the Sydney Morning Herald with jail for having the temerity to ask questions at a press conference. But many small investors sustained crippling losses. By early December, the stock market had fallen by more than 50 per cent from its October high. Within months Li had been arrested on corruption charges, for which he later went to jail himself.
Memories of 1997 are even more painful. Scarcely had Hong Kong’s handover hangovers faded, when Thailand devalued the baht, triggering a wave of currency devaluations across Asia. Hong Kong, at the height of a real estate boom, was already looking expensive relative to other business centres in the region. Suddenly, the devaluations made the rest of Asia a great deal cheaper.
Watch: How Hong Kong housing has changed in 20 years
Prevented by its fixed exchange rate from devaluing its own currency, Hong Kong was forced to make much of the adjustment through its asset markets. Between August 1997 and August 1998, the Hang Seng stock index cratered by 60 per cent. The adjustment in the city’s property market was slower, but even more vicious. From their 1997 high to their eventual 2003 low, residential prices in Hong Kong slumped by 69 per cent, inflicting grievous losses on legions of home-owners.
Then came 2007. The collapse of two US structured credit funds in July that year signalled the start of the sub-prime crisis, the credit crunch, and the global financial crisis that followed. Initially, the Hong Kong market was barely affected, with local stocks riding high on a wave of investor enthusiasm for Chinese equities.
But at the end of October the rally ran out of steam. Over the next 12 months as the global crisis worsened, the Hang Seng again plunged, losing 65 per cent of its value. The fall in the property market was less severe, but still painful. Between March 2008 and December the same year, Hong Kong home prices lost 23 per cent of their value.
The Hong Kong stock market has never regained its 2007 highs. The same cannot be said of the local property market, where prices have risen more than 180 per cent since their December 2008 low. And it is the Hong Kong property market that is the focus of concern about a new crash in the second half of 2017.
There is of course, nothing inherently ominous about years that end in a seven. But neither is it complete chance that market crashes seem to occur at regular intervals every 10 years. The reason is simple enough. Crashes typically prompt a regulatory response and a deleveraging from investors that sooner or later restores stability in the markets. And that stability itself breeds instability, as investors lulled by a false sense of security take on more and more risk. Eventually the build-up of risk becomes excessive, and the whole cycle starts again. On the evidence of recent decades, the process takes about 10 years.
Certainly the Hong Kong property market looks primed for a renewed crunch. Encouraged by rock-bottom interest rates, in recent years property investors have taken on more and more mortgage debt. In April, outstanding mortgage loans in Hong Kong totalled HK$1.14 trillion, almost three times as much as at the height of the 1997 bubble.
So far, borrowers have not been affected by the four successive increases in US interest rates since December 2015. While short-term US interest rates have risen, Hong Kong dollar interbank rates, to which most mortgage rates are linked, have remained stubbornly low. Today, the one-month Hong Kong dollar interest rate is 0.8 percentage points below the equivalent US dollar rate, holding mortgage service costs down for Hong Kong borrowers.
But this happy situation cannot last. Over the last six months the Hong Kong dollar has slowly retreated from the strong side of its permitted trading band against the US dollar. Right now it is bang in the middle. When it reaches the weak side of the band, which on current form is likely to be before the end of the year, the Hong Kong Monetary Authority will begin buying Hong Kong dollars, the local monetary base will shrink, and interest rates will rise, pushing up mortgage rates for both existing and new borrowers.
That’s going to hurt. Mortgage payments already eat up between a half and two-thirds of disposable household income for typical borrowers. By the end of the year that proportion is likely to exceed 90 per cent for more highly leveraged homebuyers, similar to the level immediately preceding the 1997 property crash.
Alas, it looks as if the curse of seven could strike Hong Kong yet again. ■
Tom Holland is a former SCMP staffer who has been writing about Asian affairs for more than 20 years