History has determined a simple way to play the Hong Kong stock market. For a roller-coaster ride through its agonies and ecstasies, simply buying property developer stocks has provided a sure path to riches. Six firms control 65 per cent of private housing supply, dominate government land auctions and have maintained gaping profit margins above 50 per cent. All can thank the profit elixir of limited land supply, more potent this year than at any other time in the past decade. Yet, even as home buyers scramble to the latest pre-sale offers, promising another bout of speculation, property stocks have been this year's great disappointment. After a strong end to 1996, the sector has underperformed. The Hang Seng property index has trailed the boarder market by 12 per cent. Many stocks are actually down on early year levels. With China investing all the rage, property is playing conspicuous second fiddle. Many argue this is a temporary affair, caused by investors' fickle obsession with red chips, that will surely correct with the next investing theme. Expect a retreat to property once Beijing spikes the red-chip bubble by cracking down on the reckless giveaway of state assets. The idea of a rotation towards property stocks - allowing a seamless elevation of the bull market onward and upward - is the stuff of stock broker dreams. Of course, a benign United States interest rate picture would help things, but what of the underlying strength of the sector? Even by developers' rarefied standards, the 1990s have been phenomenally profitable. Mistaken estimates of population growth meant too little land was released. A more drawn out project approval process and a civil service distracted by huge infrastructure works compounded the effect. Only 20,000 new units were completed last year, compared with an average of 35,000 units in the late 1980s. The consequence was fantastic price rises, lubricated by the speculative grease that so stirs political anger. Chief Executive-designate Tung Chee-hwa says he will sort out the housing crisis by releasing more land. For investors - and do not forget the Patten administration said something similar - the question is what this means for developers profits. Cartels benefit from keeping supply tight and prices high. More flats should mean lower prices and - crucially for developers - reduced profit margins. A recent Morgan Stanley study says developers assume average gross profit margins of 56 per cent. A further 10,000 units - with margins unchanged - would add 24 per cent to 1996 profits. Should the developers slice fall to 50 per cent, profits would rise only 15 per cent, and in the event that margins fell to 45 per cent, that growth would be eroded altogether. The bank is broadly upbeat on developer earnings, seeing prices being relatively unaffected by increased supply. Demand is reckoned to be price 'inelastic'. If correct, demand for new properties should see prices rising on a steady, if not so spectacular, curve. Such forecasts demand huge caveats. History may be an interesting guide but Hong Kong is headed for unchartered waters. Interest rates are sure to rise and capital inflows from abroad are likely to slow at some point. Huge growth in property debt - outstripping economic growth - has been registered by Hong Kong residents and developers alike. Perhaps stock market investors are telling us something about the future profitability of the sector after all.