Asia Perspectives - Investor sentiment for Hong Kong stocks on better footing, but headwinds persist for the economy

Highlights: The domestic Hong Kong equity market has performed strongly so far this year, advancing 16.4 per cent YTD, outperforming the Asia ex-Japan’s 9.6 per cent over the same period. In our view, there have been a number of factors which has supported the rally, including the capital inflows that led to a sharp drop in the Hong Kong Interbank Offered Rates (HIBOR) since early May, a pick-up in Hong Kong IPO activity, signs of recovery in mainland Chinese economy, as well as consistent southbound inflows via the Stock Connect. However, we note that there are lingering challenges for Hong Kong’s economic outlook. We stay neutral in Hong Kong equities.

• Historically, as compared to other Asian markets, Hong Kong equities, with interest rate-sensitive sectors such as financials and real estate being a large part of the universe, are in general more sensitive to interest rate movements. The fall in HIBOR since May and the expected Fed rate cuts in the coming months should be supportive for Hong Kong equities
• The liquidity in the banking system, as evident by the low levels of HIBOR, could be switched into equities if the investor sentiment continues to improve. The low levels of HIBOR could also have incremental positive implications for Hong Kong residential property if positive cost of carry (rental yield net of effective mortgage rates) resumes
• While the investor sentiment for Hong Kong has turned somewhat more favourable, retail sales remain under much pressure on changes in consumption patterns of both Hong Kong residents and mainland China tourists. We are also cautious on Hong Kong’s growth outlook for the coming quarters as global tariff and trade uncertainties will likely put more pressure on external demand, considering trade accounts for about 20 per cent of Hong Kong’s GDP
• Currently at 12-month consensus forward P/E ratio of 13.5x, Hong Kong domestic stocks remain inexpensive relative to global equities. We retain a neutral position as we look for more evidence of a sustainable improvement in the fundamental outlook of the Hong Kong economy, the budget deficits and corporate earnings. We see tactical opportunities among undervalued sectors and stocks signalling growth recovery and offering stable cash returns. Banks, insurance, telecom, and utilities provide stable dividend income prospects and can re-rate in a low-yield environment. We also continue to focus on selective high-quality Hong Kong developers with strong balance sheets and competitive position amid improving cost of carry