Investors may underestimate reasons behind market rout

The recent equity market rout has no doubt caused quite a few casualties among Hong Kong investors. Still, some optimistic investors underestimate the magnitude of the underlying problems that will continue to plague the local equity market for many months to come.

Indeed, the big sell-off investors witnessed earlier this month was largely triggered by the Wall Street meltdown which, in turn, was touched off by investors’ rate hike concern that was deepened by the surge in US Treasury yields. That was seen by some analysts as an excuse for the long overdue share price correction after a prolonged rally.

Their confidence in the US stock market performance was based largely on solid economic fundamentals, marked by robust growth, rising employment and strong consumer spending. Unless there is a sudden spike in inflation, which seems unlikely, the US Federal Reserve is expected to maintain a cautions interest rate policy.

Hong Kong is facing a rather different set of issues that are expected to snag economic growth and throw the asset markets into confusion. Primary among those issues is the escalating trade war between its two major markets, the United States and the Chinese mainland.

Other than increasing its spending on infrastructure development, including the multibillion dollar third airport runway project, the government has few, if any, other tools to stimulate economic growth. The already low tax base has rendered further tax incentives meaningless to most businesses. And any form of quantitative easing is ruled out by the linked exchange rate system at a time when the US dollar is appreciating against most other world major currencies.

As the value of the local currency continues to rise in tandem with the US dollar, Hong Kong is hit at the same time by the erosion of its competitiveness as a service provider against other financial and business centers and the need to raise interest rates that could further curtail domestic economic activities. Numerous research organizations affiliated with banks and investment houses have already adjusted their forecast of Hong Kong’s economic growth down to 3 percent or lower for 2018 and 2019.

The dismal performance of the Hong Kong stock market in the past several months in contrast to the euphoric rally earlier was a reflection of investors’ growing concern about the economic downtrend. Prospects of leaner times ahead have prompted some labor leaders to predict a rise in unemployment and decline in average wages across all sectors of the economy.

That is a bad omen for the highly geared property market. Until last month, banks had maintained lending rates unchanged despite several rate hikes in the US to avoid rattling homebuyers and mortgage borrowers. They were able to do so against the backdrop of a large inflow of overseas capital that had helped bolster the value of the Hong Kong dollar against its US counterpart.

But in recent months, there has been a constant net outflow of capital to the US, forcing the Hong Kong Monetary Authority to defend the peg exchange rate on numerous occasions by buying Hong Kong dollars in the open market to prop up its value. Last month, the major banks raised their benchmark best lending rate for the first time in 12 years.

In fact, the property market had begun to soften before that in August when the latest official data showed a month-to-month decline in average home prices in all market segments. Nobody is predicting a crash and economists agreed that the best-case scenario is the gradual deflating of the property bubble which has ballooned to a bursting point.

But even a progressive decline in average prices could hit the many so-called “subprime” mortgage borrowers by denying them the option to restructure their loans when interest rate increases become too great a burden for them to bear. Results of various surveys showed that many of these families are already paying up to 80 percent of their monthly household incomes on loan repayment.

If there is a silver lining to the gathering dark cloud over the economic horizon, it can be found in the resilience of Hong Kong people in the face of adversity. Past experience showed that even in the worst of times brought about by the outbreak of the Asian financial crisis in 1997 when property prices tumbled 60 percent in a year and the unemployment rate shot up to over 10 percent, defaults on mortgage loans were rare.

With the large foreign exchange reserve at its disposal, the HKMA has the resources to ensure progressive increases in lending rates while defending the exchange rate of the Hong Kong dollar.