From hero to zero: Why Hong Kong equity performance is the weakest in Asia?

Hong Kong stocks have gone from hero to zero with seemingly endless waves of regulations. Back in January 2021, Hong Kong was indeed the best performing Asian market. But the fragility is shown in the divergence between Hong Kong and the rest of Asia thereafter. While the MSCI Asia Index is flat so far in 2021, the Hang Seng Index has plunged 11% year to date. As we expected,?investors have become more sensitive to policy risks, meaning the few rounds of rebound have not been persistent. In this note, we analyze the drivers behind the weakness of Hong Kong’s equity market and its outlook.

Beneath the underperformance of Hang Seng Index is the gloomy market sentiment. Hong Kong now has the poorest market sentiment within Asia, prompting capital outflows from both foreign investors and Mainland China. Hong Kong is also the only Asian market falling below its 50-day and 200-day average.

For Hong Kong, the predominant drag is the policy risks from China’s regulatory crackdown. The exposure of Big Tech and real estate in Hong Kong equities also means the market impact is amplified. Since 2019, Hong Kong has welcomed China’s Big Tech firms, especially through secondary listings in the light of the US regulatory threat. The share of communication services, consumer discretionary and health care has increased from 28% in 2019 to 37% in September 2021, overtaking financials and real estate, which form 27% and 7% respectively.?The shelters from tightening regulations, such as semiconductors, are not well represented in the Hang Seng.

Such fragile sentiment does not only react to policies in Mainland China but also their extension in Hong Kong, such as the potential higher supply of land and the implementation of anti-sanction law, which?implies ongoing geopolitical tensions. The proportion of stocks that closed lower has increased from 47% in Q2 2021 to 67% in Q3 2021.

As if this were not enough,?the fall of Evergrande has casted doubts over the stressed real estate sector. On 23rd September, Evergrande has honored the coupon payment for its onshore bonds but missed the deadline for offshore bonds with grace period. Any missing payment will send a larger shockwave in Hong Kong than China’s onshore market.

In conclusion, the tailwind in tech-related listings has now become headwind in stock performance, which is in conjunction to the weakness of the HKD. The signs of capital outflows in Hong Kong are in clear contrast to renewed foreign inflows into Asian shares. The FED’s tapering is a risk for Asia, but even more for Hong Kong with a dollar peg. This means Hong Kong financial conditions could be tighter passively with extra pressure from the broader and tighter regulatory crackdown in Mainland China. The situation looks like a falling knife, which may push investors to diversity through other Asian markets.?

Full report is available for Natixis clients.