Our Opinion: 2020

Hong Kong’s struggle continues

Hong Kong’s recession deepened in the first quarter of 2020, contracting 8.9% year on year. Stocks have a weak earnings outlook, and residential property prices are likely to fall by up to 10% this year.

Signs of virus containment globally and economic reopening in China supported the performance of Chinese stocks in April. But resurfacing US-China trade tensions, are likely to keep volatility high. US rhetoric is likely to stay heightened ahead of the Presidential elections. But since a renewed escalation with China would hurt the US economic recovery, President Trump’s actions should be tempered.

Still, Hong Kong equities and real estate look unattractive.

Despite the containment of COVID-19 in Hong Kong, its economy is not yet out of the woods. The stack of challenges faced by the city, including prolonged weakness in tourism, renewed US-China trade tensions and local uncertainties, should keep activity weak in this second quarter and slow the growth recovery.

Hong Kong is set for a deeper recession than mainland China. As a service and trade-driven economy, the city has been reeling since the recession which started in July 2019.

A substantial part of HK’s economy is closely related to mainland China’s economy, including export, finance and consumption sectors, so lower growth there will weigh heavily. External trade and private consumption bore the brunt of the pain with double-digit year-on-year declines, as service activities and tourism stalled amid the pandemic and tightened containment measures. Travel restrictions and quarantine requirements may not be lifted until late this month, or June, pointing to slow recovery in economic activity in the near term. This means retail sales, which saw a record decline of over 40% year on year in the first quarter will stay weak amid plunging inbound tourism and a weak labour market. Export growth will also struggle given slumping external demand and travel controls.

Growth should return in the second half of the year as the World, especially mainland China, recovers and the virus impact fades, and thanks to the implementation of fiscal support. But given the deep contraction in the first half of the year, and with external and local uncertainties lingering, UBS is projuecting a growth projection of -6.8% in 2020. This would mark the weakest output since 1998, and is in line with the latest government guidance of –4% to –7%.

The gradual containment of COVID-19 in China and strong stimulus package have strengthened investment sentiment toward Chinese equities. This has effectively driven the valuations of Chinese stocks back close to long-term averages. In contrast, Hong Kong’s earnings outlook remains weak, especially in the financials and consumer sectors. It also appears that the market is too optimistic, especially given the COVID-19 virus, China-US tensions and the fact that domestic turbulence could all flare up again. The MSCI HK index is currently trading near its long-term average price- to-earnings ratio which looks unjustified given the weak outlook and rising uncertainties.

Despite the weakening economy and rising unemployment in HK, home prices have so far only fallen 1% this year (down 8% from the peak in 2019). Home prices may therefore not reflect the actual downside pressure, with limited transaction volumes related to the travel restrictions. Hong Kong residential prices are likely to fall by 5%–10% in 2020, with low interest rates and limited supply preventing an even greater decline.

Chinese equities have risen 4% over the past month, driven by the gradual peaking of the COVID-19 pandemic in US and European markets. Beijing’s policy stimulus and gradual normalization of leisure and domestic travel activities have also boosted sentiment.

However, escalating Sino-US tensions and economic uncertainty will likely keep volatility elevated in the short term.

13th May 2020