Written by Laurence Yang
When the closing bell of the HKEX rang on Friday January 26, 2018, stock investors and public company owners in Hong Kong left their office with a tremendous amount of optimism - the Hang Seng Index (HSI) just closed at yet another record high at 33154, after a 10% rally in January alone. What most of them did not expect was that they would not see the HSI trading at this level again for many years to come.
So, what happened to this HSI since then?
As of the writing of this this article on October 13, 2022, the HSI is trading at around 16500, a staggering 50% decline from its all time high made over 4 years ago.
However, the spectacular drop does not come as a surprise to a lot of investors given how turbulent (to say the least) the past four years has been for Hong Kong and mainland China.
In Hong Kong, a months-long anti-government movement that brought the city to its knees was followed closely by the emergence of a crippling pandemic that isolated the city from the rest of the world for more than 3 years.
The situation does not look any better in mainland China, where over 70% of HSI's constituent companies are headquartered. In 2018, the Trump administration initiated a full-fledged trade war with China (including the removal of Hong Kong's special trade status with the US in 2020). The outbreak of COVID-19 in 2020 only further deteriorated China's relationship with not only the US but also other major industrialized nations. To make matters worse, Russia's invasion of Ukraine followed by China's reluctance to criticize and sanction Russia divided China and the US (and its allies) even further.
In an article we published almost a year ago, we discussed some of the domestic headwinds in China:
Low birth rate coupled with an aging population has been one of the top concerns of the central government in Beijing, which led to the regulatory framework been tightened, particularly when it comes to industries that are seen as 'endangering youth wellbeing' in the country.
Crackdown on the real estate sector, which is seen by the Chinese government as the main driver of inflated cost of living and the reason why the younger generation in China are reluctant to have children.
More regulation for private companies like Tencent and Alibaba on how they handle user data.
Officially and unofficially discouraging Chinese companies to list on foreign stock exchanges. Prime example: during its IPO on the NYSE, Chinese ride-sharing giant DiDi found itself caught in the crossfire between the SEC and the Chinese securities regulator CSRC.
All these developments combined with an aggressively tightening Fed (the Hong Kong Dollar is pegged to the USD and follows the monetary policy of the Fed closely) is a "recipe for disaster" in the Hong Kong stock market.
In one sentence: the HSI has been suffering from every single front over the past four years.
When will the HSI bear market bottom?
Positive catalysts, such as the anticipated easing of both COVID-19 restrictions and geopolitical tensions, paired with policy loosening, may help the Chinese equity market recover, according to Franklin Templeton Emerging Market Equity’s Michael Lai.
In a September 2022 report, Franklin Templeton (FT), one of the world’s largest investment managers, identified several positive catalysts that could help China’s market recover. These include an easing of zero-COVID restrictions, a reduction in geopolitical tensions and clear evidence of no further tightening in the regulatory environment. FT sees reasons for optimism in each area. The government is likely to continually adjust COVID-19 policies—driving greater economic resilience and flexibility in the face of localized restrictions—and utilize flexible policy tools. FT also anticipates stabilization in earnings revisions, and a regulatory shift toward implementing previously announced policies vs. incremental new tightening measures.
Technical outlook of the HSI
Below is the monthly chart of the HSI going all the way back to the 1980s.
It is evident that the index has been in an uptrend since the 1989 low, holding above the blue uptrend line every single time - including the 1998 Asian financial crisis, the 2000 dot-com burst and the 2008 GFC crash.
As of the writing of this article, the HSI is trading right around the 33-year-long uptrend line, which in our view, should offer a tremendous amount of support for the index.
Additionally, as we mentioned above, the index has dropped 50% from its all time high - a number where many big-cycle corrections ends (i.e. the S&P 500 dropped 54% from its 2007 peak before a major bottom was formed in March 2009; during the 2020 COVID-induced crash, the Dow bottomed at exactly 50% retracement from its 2009 low).
LHG expects the HSI to finish its multi-year big cycle correction and form a major bottom soon.
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