Hang Seng Index is the benchmark index for Hong Kong. The index represent 50 of largest companies listed in Hong Kong. Since China’s financial system is a closed to the outside world, the Hang Seng share market is commonly refered to as the proxy for the Chinese market.
The Hang Seng index today is a shadow of its former self where the last secular peak was in Jan 2018 when it reached 32,000. The ensuing China slow down, trade wares then the onset of the protest has battered the market sentiment and the performance of the index where it has been range bound ever since.
The most recent bottom of 21,700 driven by the global sell off from Covid and the sharp reversal make us question if the index has true reached a cyclical bottom.
The key risks for Hong Kong has always been the ever encroaching control of China and its eventual takeover from a special administration region to a wholly owned Chinese city. Hong Kong thrived post 1997 as result of the unprecedented rate of growth however the recent political turmoil has accelerated the takeover process has as result the market has rerated from a semi-developed market to in our view a true emerging market.
The uncertainty in the future of Hong Kong has been the primary driver in the weak performance of the Hong Kong Stock market in the least 2 years.
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Why We Like The Hong Kong Stock Market
- The market is being priced at historical p/e ratio of sub 10 and we think the downside is limited. After it doesn’t take much for a quick rebound if the sentiment turns from bad to less than expected bad. A key outlier is a quieting of the political turmoil as the Chinese government refocus their attention in job creation to forestall risks of domestic issues on the mainland as result of the economic slow down post Covid. China will focus more on the economy and jobs going forward and that means the political issues of Hong Kong will take a back seat.
- Companies are being sold off indiscriminately whether their revenues and earnings are from the mainland or Hong Kong. This is the perfect opportunity to selectively pick up bargains of the mispriced opportunities.
- The V-shaped recovery in the Nasdaq can be seen to forestall a migration of capital from overheated markets to underpriced markets. Hong Kong is priced attractively and the largest company in the Hang Seng is Tencent, a giant with monopoly control in China through WeChat. WeChat can be simply thought of as Facebook, Google, Paypal and WhatsApp combined in one.
- Hong Kong has been rerated from developed market to rightly an Emerging Market but that is ok as it currently is the best Emerging Market amongst its peers. On a relative basis, the other key Emerging Markets like Brazil, Russia and South Africa has been fraught in their management of Covid and as result in our view is uninvestable for the short or medium term. You have to be pretty brave to allocate any capital in those markets.
- It is suprising markets like the Standard and Poor’s 500 has recovered this much so quick but we have a more cautious view. Thematically we like exposure in markets where Covid has been managed with limited long term structural damage to the economy. This is one of the reasons we are more bullish on Asia in general vs US and Europe. Until there is a medical solution to the crisis we feel any market where Covid is not under control is an uninvestable market.
Hang Seng Stock Index Performance
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Key Risks Investing in Hong Kong
- The Hong Kong dollar is effectively pegged to the US dollar at 7.8 per USD. A key risk is a depegged due to outflow of capital flow if political risk moves up another level. We think given where the HKMA reserves are at today the peg will hold. Afterall any dangers posted to the HKD peg is a political choice rather than economic risk.
- Secular change to Hong Kong as a developed market. If you were an existing investor invested in Hang Seng stocks pre-crisis then you woud’ve already taken the pain in market’s rerating of Hong Kong from developed market to emerging market. We feel the risks today has been priced in and we are being rewarded for effecitvely taking emerging market risks with approriate upside.
A key assumption from above is that the political environment does not deteriorate from bad to worse but like any investing in emerging market, the political consideration is just as important as economic factors.
There is no doubt China is putting a squeeze on Hong Kong but one of the strength of Hong Kong is that it is a key avenue of capital flow in and out of China. We think that an elimination of Hong Kong as an entreport for Chinese capital will poses significant capital flow risks for China it self. Whilst there are consensus in trying to get Hong Kong closer to China, there are simply too many stakeholder will lose out if its special status is entirely eliminated.
It is always difficult to make political forecast but there is a silent red line China will push in the medium term. It our view from where the Hang Seng Index chart today is good for at least a trade.
How to Invest in the Hang Seng Index?
One avenue for this trade is to take direct exposure via the Hang Seng Futures traded in Hong Kong which tracks the performance of the underlying index.
However we think another way of taking advantage of the cyclical rebound is to buy Chinese stocks listed on Hong Kong. These companies have been sold and are trading discount to historical metrics.
Of the list of ETF on the ASX there are no funds which tracks the Hang Seng index. However iShares China Large-Cap ETF (ASX IZZ) tracks an index which owns 50 of the largest Chinese companies listed in Hong Kong. Ironically it has performed better than the Hang Seng index recently. This would be an ideal vehcile to execute the trade.
Owning the index is an indirect exposure to Hong Kong as there are a number of overlaps between the underlying index of ASX IZZ and the Hang Seng. The predominant difference being the exclusive of HSBC and HK based developers.