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Cheap stocks to get cheaper

THE market has moved ahead strongly over the last couple of weeks but - apart from the small matter of this being the cheapest of all the major markets in the world - there seems little reason to dive in at this point. The political dispute remains unresolved, with the likelihood of further conflict increasing as we draw ever nearer to the Governor's policy address, scheduled for October 6. More importantly, it is unlikely that we shall see improving economic data out of the mainland before the first quarter of 1994. Even then there will be a time lag before the inflation figures show any improvement.

For Hong Kong investors, Zhu Rongji's clampdown potentially creates two problems. Firstly, any slowdown on the mainland will inevitably impact upon the local economy. We estimate the potential damage at between 0.5 per cent and 1.2 per cent of local GDP growth in 1994. Indeed we are already seeing a slowdown in exports to China which (together with the sluggishness of the recovery in the US) suggests that the government's forecast of 5.5 per cent growth for this year will prove overly optimistic.

Secondly, and more difficult to quantify, are the consequences of an inevitable slow down in mainland investment in Hong Kong. Despite official denials to the contrary, it would now be extremely surprising if we did not experience some degree of repatriation of funds to the mainland. The Hong Kong property and stock markets have been major beneficiaries of Chinese investment in recent years and the consequences of any slowing, or indeed reversal of this trend are obvious.

So where does that leave us? I believe this market to be outrageously cheap at these levels, the problem is I suspect it will get cheaper. The prevailing uncertainties will act as a powerful disincentive for investors, particularly overseas institutions who have been the prime driving force in recent years. Thus we may be facing a couple of quiet months.

Nearer the end of the year I expect this market to positively power ahead, reaching record highs before year-end and breaching the 8,500 mark shortly thereafter. Why? Because by that time the political dispute will have been resolved, the focus will haveshifted to '94 earnings, and most importantly, investors will be anticipating improved data from north of the border.

So what should we be doing now? Probably not a lot. The interim announcements should as ever create some decent trading opportunities. For example, Hutchison's figures will be good, sell on strength, Swire's will look bad, buy on weakness; but overall there's probably not much point in piling in at this stage.

Those prepared to take a longer term view are advised to accumulate the blue chips on any weakness. The important thing is to ensure that you are in this market before the year-end rally.

Clive Weedon is head of research, Nomura Research Institute Hong Kong