Higher rates could bring asset price rally to a halt

The strong performance of the Hong Kong stock market in the first week of the New Year is a strong indication of investors’ growing confidence that the global stock rally will continue into 2018. Their confidence is shared by investors in most other major markets which did almost as well as Hong Kong in the past year. The United States’ lead indicator, the Standard & Poor’s 500 Index, surged more than 400 points, or 19 percent, last year while Japan’s Nikkei-225 Index gained nearly 20 percent.

Other markets in developed economies also made impressive gains. Despite Brexit uncertainties, the United Kingdom’s benchmark index rose 7 percent to a record high.

The boom has been attributed to a combination of factors, including robust economic growth, particularly in the US, Europe, Japan and the Chinese mainland. Hong Kong’s GDP growth forecast was raised to 3.7 percent, compared with an average growth rate of 2.8 percent in the past decade.

The Hong Kong stock market was further boosted by a sustained inflow of overseas capital which helped push up prices of many major H shares of mainland enterprises, especially those of tech giant Tencent, which has a heavy weighting in the benchmark Hang Seng Index.

Many analysts believe the economic boom that drove the global market rally last year will continue this year. The Organisation of Economic Cooperation and Development predicted a slightly faster growth for this year than the year before. Forecasts from banks and investment houses range from 3.2 percent to 4 percent.

As with last year, major momentum for global economic growth will continue to come from the US where the new tax cuts and proposed infrastructure spending increase are expected to boost corporate investments and consumer spending.

But some analysts have warned about potential pitfalls arising from rising interest rates. They warned the US economic stimulus could cause the economy to overheat, forcing the Federal Reserve to raise borrowing costs more aggressively than expected.

Inflation is not a threat despite oil prices firming to $60 a barrel from $40 not long ago. In fact, some inflation is seen to be good for the economy, especially in Europe and Japan. The fear is that central banks may overreact to signs of inflation and raise rates too aggressively, risking pushing the economy into a recession.

Hong Kong people were served a reminder of price inflation when McDonald’s raised meal prices at the beginning of the year. It’s widely

An increase in borrowing costs, which seems inevitable, could discourage an increasing number of prospective buyers from making the plunge.

expected that other fast food caterers serving working people will follow suit soon.

This has raised concern that supermarkets, utility companies and service providers will also increase prices ostensibly to cover the rising cost of labor and materials. Many people have resigned to the fact that public transport fare increases are unavoidable.

Scary as inflation may seem to the average worker, investors don’t share the same concern. They expect asset prices will go up when purchasing power of the currency sinks. But things don’t necessarily work that way.

The rapid appreciation of asset values in Hong Kong was due, to a large extent, to the persistent low cost of funds. Years of near zero, or negative, real interest rates have convinced many people that properties are the best store of value.

In the buying frenzy, many homebuyers borrowed heavily to fund purchases at prices fewer and fewer people can afford. Surveys have shown that monthly mortgage repayments ate up more than half of many household incomes.

An increase in borrowing costs, which seems inevitable, could discourage an increasing number of prospective buyers from making the plunge. The resulting fall in domestic demand could force some highly geared developers to cut prices of new homes. Signs of a possible property glut would, in turn, prompt investors and speculators to unload their holdings before bankers come knocking on their doors.

A depressed property sector would almost certainly short-circuit any stock market rally because nearly all the major listed Hong Kong companies and banks are involved, either directly or indirectly, in property investments.

Unsurprisingly, the government, which is the biggest landlord in town, has cautioned investors about the possible impact of rising interest rates. Those investors who are trading on margins should take note.