Don’t read too much into the Hang Seng Index’s remarkable November comeback
- Nicholas Spiro says Hong Kong’s benchmark index has made a dramatic recovery, ahead of a cooling-off period in the trade war. But uncertainties loom in both the US and Chinese economies, to which the index is tightly linked
As far as rebounds go, the 6 per cent rise in the Hang Seng Index last month has got to be one of the most remarkable this year. Hong Kong’s benchmark gauge not only outperformed the MSCI All Country World Index, which rose 1.3 per cent, but also came back from its longest losing streak since 1982, according to data from Bloomberg. Even emerging markets, which performed the strongest among the main regions last month, lagged behind the Hang Seng.
For a leading index that is acutely sensitive to developments in both China and the United States, the Hang Seng’s outperformance is striking, considering the trade war between the world’s two largest economies. Although the Chinese and US presidents declared a ceasefire at a meeting last Saturday, following the G20 summit in Argentina, the issues that gave rise to the conflict remain unresolved.
So what accounts for the Hang Seng’s impressive gains? A significant part of November’s rally stems from the dramatic recovery in the shares of Tencent Holdings, the Chinese internet giant that is Hong Kong’s largest listed company with a 9 per cent weighting in the index.
After plunging 38 per cent between early June and late October, Tencent’s stock has since risen 22 per cent, buoyed by stronger-than-expected third-quarter earnings despite a regulatory clampdown that threatens the firm’s core games business. According to data from Bloomberg, Tencent enjoyed its best monthly performance on record versus Apple, whose stock plummeted a further 19 per cent last month.
Yet strip out the Tencent effect, and the Hang Seng’s sharp rebound is hard to explain, and harder to justify. Throughout the year, the role of Hong Kong’s equity market, the world’s fourth largest by market capitalisation, as a barometer of regional sentiment has been amplified by the two main vulnerabilities in the markets: the US’ tightening monetary policy and China’s economic slowdown.
Between mid-May and the end of October – a critical period when worries about the Chinese economy and fears about a Federal Reserve-led tightening in financial conditions generated a fierce sell-off across a growing number of asset classes – the Hang Seng suffered an even sharper decline than the Shanghai Composite, the world’s worst performing major equity market this year.
This is because Hong Kong stocks face the worst of both worlds. On the one hand, the shaken confidence in China’s economy has not only hurt the mainland stocks that dominate the Hang Seng but also reduced onshore demand for Hong Kong’s shares. According to Bloomberg, mainland investors have sold November’s rally, dumping about US$750 million of the city’s stocks via trading links at the end of last month, the longest selling streak since August.
Southbound flows are unlikely to pick up meaningfully any time soon, given the continued fallout from China’s deleveraging campaign. Data published last Friday shows China’s manufacturing sector on the verge of contracting last month, with new export orders shrinking for the sixth straight month despite recent efforts by Beijing to stimulate growth. The longer the sense of policy confusion in China persists, the less likely it is that selling pressure from the mainland will abate.
Hong Kong stocks are also under pressure from rising US interest rates, made more acute by the city’s currency peg to the greenback. Residential mortgage applications plummeted in September as the city’s main banks began hiking their lending rates for the first time since 2006. New home sales, meanwhile, slid to their lowest levels last month since early 2016, fanning fears that the world’s most expensive housing market is experiencing the start of a major correction.
While Fed chair Jerome Powell’s comments last Wednesday were interpreted by markets as a sign of slowing monetary tightening next year, an earlier-than-expected pause in the Fed’s rate-hiking cycle would only heighten concerns about a sharp slowdown in the US economy.
Such a scenario would further undermine sentiment in Hong Kong’s vulnerable equity market, where weak growth is a greater source of anxiety than rising interest rates, especially after the city’s own economy slowed to 2.9 per cent in the third quarter, the weakest quarterly performance in two years.
The Hang Seng’s tight links with financial and economic developments in China and the US allow more scope for an externally driven rally if concerns about the economies and markets of both countries dissipate. However, this is a tall order. While a cooling-off period in the trade war may help lift sentiment in the coming days, domestic uncertainties in the world’s two largest economies, especially China, will persist. The Hang Seng’s surge last month was almost certainly a blip.
Nicholas Spiro is a partner at Lauressa Advisory