Why It Might Be Time For Hong Kong Stocks To Come BackThe Chinese economy is currently facing challenges, and the momentum of Chinese stocks is not great. It may seem questionable why anyone would choose to invest in Chinese stocks when there are other high-performing options available.
Yesterday, the leader of Hong Kong expressed his intention to enact stricter national security laws in the near future. These laws would build upon the comprehensive legislation imposed by Beijing on the city in 2020. The leader emphasized that Hong Kong "could not afford to wait" in implementing these measures.
This development is being closely monitored by businesspeople, diplomats, and academics. There is concern that the new laws, specifically Article 23, which would target espionage, state secrets, and foreign influence, could have a significant impact on Hong Kong as a global financial center.
Is it a good opportunity to buy Hong Kong stocks now?
It is important to remember that during times of deep pessimism, there can be high opportunities for investors. Warren Buffett often advises that it can be profitable to be greedy when others are fearful, and vice versa.
In the short term, investing can be driven more by narratives and emotions rather than fundamentals. This can cause prices to deviate from their true value. Eventually, prices reach an extreme and start to revert back to a more reasonable level.
From both fundamental and technical perspective, we may be approaching such a turning point for HSI:HSI , as extreme bearishness has led to low valuations that have historically preceded significant price rallies.
While valuations may not be the best indicator for short-term returns, they are crucial for long-term returns. Currently, the valuations of Hong Kong stocks, trading at a Price-to-earnings ratio (PE ratio) of 7.5, are at record lows compared to their own history and other markets. This makes them attractive for long-term investors.
The current valuations offer a margin of safety, as it would take a significant deterioration in the situation or an extended period of poor performance for valuations to be lower than they are now. Since 2009, there were 3 times the Hong Kong stocks’ PE ratio traded below 10, highlighted in the chart above. And all 3 times had offered investors good returns, from 10% to 60%.
The current low valuation has been started since Aug 2022. We feel that a small rebound in valuations to more normal levels could generate attractive returns, even if the companies' earnings are not exceptional. Historically, the best returns have been achieved when starting valuations were low and the profit outlook was not optimistic.
Summary
It's important to note that Hong Kong stocks may not perform as well over the next decade as US stocks did in the previous one. However, if you are willing to hold onto these stocks for long term, they could offer enhanced returns and geographical risk diversification.
