2007 was a good year for holders of Hong Kong assets. 2008 could be even better. Owners of Hong Kong stocks and properties have a lot to celebrate as this year ends. At Friday's close, the benchmark Hang Seng Index was up an impressive 37 per cent over the year (see chart). Even that handsome return understates many of the equity market's gains, however. The Hang Seng's performance was weighed down by a few local and internationally focused laggards. Mainland-slanted stocks were on steroids, though. The H-share index was up 55 per cent, while the red chips returned 80 per cent. But for all the hullabaloo over the stock market, equity investment remains a minor sport in Hong Kong. For most people real estate still reigns supreme. And in the property market too, there was reason to cheer. The latest figures for the Centa-City real estate index show residential prices rose a robust 11.4 per cent over the first 10 months of the year (see chart). But again, that number understates the returns made by many. Centa-City's leading index has ticked up sharply over recent weeks, implying a 27 per cent gain over the year as a whole. At these levels, property prices have now doubled since the dark days of the Sars scare in 2003. Given the magnitude of the gains made in 2007, investors could be forgiven for deciding it was high time to book profits and take some of their money off the table. That would be a mistake. The signs indicate that although 2008 could well be another volatile year, asset prices are likely to carry on rising over coming months. In fact, there is a real probability that the current bull market in Hong Kong stocks and properties could inflate into a full-blown bubble next year. Many of the conditions are in place. Most notably the United States is cutting interest rates in response to the subprime crisis, dragging Hong Kong rates lower, while imported food price rises from the mainland mean inflation is climbing. With consumer prices up 3.4 per cent in November and the Hong Kong dollar savings rate at just 1.5 per cent, bank deposits rates are already negative in real terms. That is just the start. According to analysts at HSBC, a series of US cuts is likely to push Hong Kong interest rates down by a full percentage point over next year. Meanwhile, prices will continue to climb, propelled by a combination of more expensive imports and a tight labour market pushing up wages at home. HSBC economist George Leung says the inflation rate could well hit 5 per cent early in 2009. By that time, savings deposits will be losing 4.5 per cent a year, while the mortgage rate could be minus 2 per cent in inflation-adjusted terms. Expect money to flow out of banks and into assets, pushing prices sharply higher. Even the usually cautious Asian Development Bank is flagging the possibility. Not only is Hong Kong inflation likely to rise, its economists warned earlier this month, but 'excess liquidity could also cause a bubble in local stock markets and fuel a real estate boom'. Even headwinds from the expected slowdown in the US and European economies may leave equity and property bulls unruffled. Usually Hong Kong's economy is a geared play on global demand. In the past, estimates Michael Spencer, regional chief economist at Deutsche Bank, a one percentage point slowdown in the US and Europe would have knocked three percentage points of Hong Kong's growth rate. This time, however, things may well be different, at least as far as markets are concerned. For one thing, mainland demand for Hong Kong services, in particular financial services, will remain strong. Some US$29 billion has flowed out of the mainland in recent months under the qualified domestic institutional investor scheme, much of it into Hong Kong. Another US$19 billion could follow on the present quotas. That will provide powerful support to local equity prices, as will the much-delayed 'through train' if it ever gets rolling. Moreover, Hong Kong is likely to continue to attract heavy capital flows from international investors. In the past, foreigners would typically reduce risk and scale back in Asia when things got difficult at home. Now there is evidence that institutions have changed the way they look at China, and that instead of cutting back, they may increase their investments as a hedge against soft markets elsewhere. Finally, much of the pain of softer external demand will be absorbed by the Hong Kong government's proposed tax cuts and infrastructure spending plans, which will keep local unemployment down and spending up. There will be setbacks, of course. There are plenty of risks out there, and volatility has taken a step upward in recent months. But in a year's time, bold investors could well be toasting 2008 with bubbles. Jake van der Kamp is on holiday
