Complacency weakens investors’ risk awareness regarding stocks

It is convenient to blame the trade war between the United States and the Chinese mainland for driving down stock prices in Hong Kong, which is caught in the crossfire.

But the real cause of the short circuit in Hong Kong’s years-long stock rally can be traced to its monetary roots, which occurred long before the outbreak of the trade disputes. It is just that most investors have chosen to ignore the signs of major shifts in monetary policy in their state of irrational exuberance.

In Hong Kong, the asset market fever was further fueled by the large inflow of overseas capital that was gobbling up stocks and properties at almost any price with little consideration of the established market standards for evaluation. Such a flood of capital into the red hot asset markets has created a lasting impression in the minds of many investors that asset prices would never fall and the cost of money would never rise.

Their belief, though branded by economists and financial officials as unrealistic, was borne out by the strong stock rally and the unstoppable rise of home prices to levels that had long ago been marked as “unaffordable”.

Of course, investors were well aware of the winds of change which began to blow by the end of 2016 when the US Federal Reserve hiked interest rates for the first time since the outbreak of the global financial crisis in 2008. What’s more, quantitative easing in the US is truly coming to an end as the Fed started to tighten liquidity by trimming its balance sheet by as much as $50 billion a month.

Elsewhere, the Bank of England said it could begin shrinking its balance sheet sooner than expected and the European Central Bank has planned to halt asset purchases by the end of this year, according to a CNN report.

But the prevailing thought in Hong Kong was one of complacency as investors believed that the city would not be affected as long as the inflow of capital continues.

Indeed, Hong Kong bank has kept their lending rates unchanged after seven increases in the US. The net outflow of capital in the past several months resulting from the widening interest rate differential with the US had done little to drain the liquidity pool.

Although the benchmark interbank rate has risen by a total of 100 basis points to about 1.6 percent a year, it is still considered too low to have banks worried about their funding costs.

Then came the trade war which has rudely brought investors back to reality. At the start several months ago, most investors brushed off the threat in the belief that the dispute would be resolved through negotiations. Instead, the conflict has kept escalating as both sides hardened their stands on the issue.

The trade war is seen to have dealt a serious blow to mainland stocks. The sell-off has since spread to the Hong Kong market which is dominated by the listings of nearly all the major mainland enterprises. No sector was spared the bloodbath. And hardest hit was the technology stocks as investors began to question their high valuations at a time of growing uncertainties.

Investors have to come to terms with the reality that the stock market punch bowl is no longer overflowing and each drink is going to cost them more. Interest rate seems almost certain to go up after the much expected rate hike in the US in September. Suddenly a credit crunch doesn’t seem as remote as was earlier thought.

Investors’ worst nightmare is a sudden and massive outflow of capital to the US to seek higher and more assured returns from rising US bond yields, a booming stock market and rapidly appreciating currency. In contrast, Hong Kong’s investment environment is clouded by a slowdown in economic growth arising from projected decline in the demand for financial and trade services.

The persistent low average turnover on the local stock market has basically ruled out any sharp rebound in share prices in the foreseeable future. While many prospective homebuyers still hang on to the belief that property prices will keep rising, some major developers and investors are beginning to lower their prices to speed up sales of their holdings.

The best hope for Hong Kong is a progressive deflation of the property bubble to avoid a sudden burst that could wreak havoc on the local economy and put tremendous stress on its financial system.