Monday, November 19, 2007

HK Calling!

The HK and China markets have been the most robust and active over the last 4 weeks. The huge Petrochina and listings have propelled momentum driven investors. Following the euphoria, the Shanghai and Shenzhen markets are going into a downtime. The markets there failed to maintain above the 150 day trendline despite trying a few times. That took some liquidity players away from the markets.

When markets experience a downshift in liquidity, people go looking for reason, and the CPI / inflationary pressures were convenint (and real) excuses. Investors were spooked when the same excuses were repeated day in day out. Those were excuses for the markets there to deflate. To me, the shift down in China markets is more a technical thing rather than a fundamental exorcism. They will need to find their feet before rebuilding, so no hurry to bottom fish in China markets as these momentum driven markets will need to build a bse first before relaunching themselves, it won't be a V-spike back up. Take your time to see the base building.

The HK market is probably the BEST long market globally for the next two quarters. The disconnect in the currency owing to its USD peg created a downward pressure on its domestic interest rates (being at a a much higher level than the prevailing rates in the US). The weaker USD automatically boosted competitiveness in HK, a sort of reverse "post Asian financial crisis". Following the 97 crisis, all Asian currencies lost between 30%-50% of their value against the USD. HK kept their peg, and hence huge structural unemployment was hitting HK the worst. Large chunk of industries which can no longer compete with the "expensive peg" were forced out. Many moved to Shenzhen if they could. Now, we are seeing the reverse - the pain before, now the pleasure. The HK market is now the BEST long market because it is a natural China play, without the frothy valuations. The HK market is also the most liquid Asian place to be. International investors have been converging there almost the same time the USD started to weaken dramatically. Funds have been redirecting capital to HK at the expense of smaller Asian markets - thats very clear over the last few weeks.

Many cited the China's "direct/through train" as the main thing which has driven the HSI up from 24,000 to 32,000. I don't think so at all. Now as China markets have corrected, the HSI has fallen in sympathy. Both are very much momentum driven markets with lots of liquidity. However, Shanghai and Shenzhen are victims of high-inflationary expectations. Not so much for HK.

The continuous delay and tighter rules proposed for Chinese mainland investors before they can buy HK shares was given as the main reason dragging the HSI lower. I don't think that's true at all. The reasons why HK markets shot up were due to reasons explained in paragraphs above. One thing though, the HK markets have been extremely volatile over the last two weeks. The day to day market swing can be between 2% to 4%. That clearly indicates to me that the underlying liquidity and bullishness. But the fact that it has failed to main above the 150 and 200 day trendlines, despite the feroucious buying would confirm that the markets there have to go lower first.

There was a 20%-30% drop in China's property transaction volume over the "golden week" in early October. A slowdown in China property and equity markets could be a potential trigger for a correction in Hong Kong, or so they say. Recent property launches in HK have seen more than 50% of these new properties being snapped up by China nationals from the mainland. The reverse reflation back to HK economy is a significant development. HK's economy continued to grow in the third quarter with its GDP rising 6.2% in real terms over the same period last year. The result marked the 16th consecutive quarter that GDP growth exceeded the average trend growth. HK's economy should be able to attain 6% growth for 2007 as a whole, with GDP growth of 6.1% in the first three quarters and given the prevailing strength in domestic demand. Now, you would have to add the impact a much much weaker USD from 4Q onwards, and that should cause some surprises in growth figures on the upside in the coming quarters.

Merchandise exports grew 6.4% in real terms, with exports to Chinese mainland and many other emerging markets growing well. Services exports grew 12.3%, reflecting strong inbound tourism, vibrant financial market activities and a continued surge in offshore trade. Domestic demand played a key role in driving the economy forward. Private consumption spending grew 9.7%, supported by the improving job market and rising household income and wealth.

So on balance, the HSI has a lot more going for it than Shanghai or Shenzhen. However, some of wind may have been knocked from the sails of HSI may be due to Chinese authorities clamping down on cash withdrawals from southern banks to try and stem the flood of illegal money boosting HK's bullish stock market run. The daily withdrawal limit from banks in Shenzhen, just across the border, has been capped at 30,000 yuan (US$4,000), and some banks have limited or stopped cash withdrawals from ATMs even. The proximity of Shenzhen to HK was the cause of such liquidity outflow, and lots of mainlanders have opened up accounts to invest in HK stock through underground money exchanges.

Apparently about five percent of HK's stock market's daily turnover comes from mainland individuals. Some estimated that half of the entire cash withdrawals from the mainland, 195.6 billion yuan in the first nine months, took place at Shenzhen banks.

Should HK be worried? Nah, the fundamentals driving HK markets are a lot stronger than patches of liquidity issues. The reflationary aspect due to the peg, coupled with a high propensity for domestic rates to go lower, should see the fundamentals winning out soon. Did I mention that a more dormant Shanghai and Shenzhen should see more funds finding its way to buy HK properties instead. That is an important development because Hk basically runs on 5 things - tourism, shipping, services, stock market and properties. Investors going through these 5 would be ticking each one positively going forward. Hence the HK markets should still be the best LONG market once it has settled down. I see a 25,000-26,000 as a good area for base building.

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