BY JEFFREY GOLDFARB

There is relative optimism about Hong Kong reflected in its stock market. That’s hard to reconcile with past and present realities. It also doesn’t bode well for the future.

The city’s benchmark indicator of equities has lagged the S&P 500 Index since violent anti-government protests started in June. Nevertheless, the slide has been less severe than during the Asian financial crisis some two decades ago or the deadly SARS breakout that followed. As of mid-December, the Hang Seng Index was down less than 7% from its July apex. That’s modest when compared with peak-to-trough falls of more than 50% during each of the previous two calamities.

The main Hong Kong index includes more mainland companies than it used to, with such notable additions as Chinese tech titan Tencent. However, more locally skewed indices and stocks – including subway operator MTR, cosmetics retailer Sa Sa International and conglomerate Jardine Matheson – have held up comparatively well through more than six months of turbulence that drove the city into recession.

Clashes are likely to persist. Even under an optimistic scenario laid out by political risk consultancy Control Risks, any de-escalation would be temporary and underlying tensions “would not fully revert to pre-crisis levels.” That’s a bad omen for tourism, shopping and property prices.

The former British colony’s fortunes are also tied to China’s economy, which has been roiled by the volatile trade war being waged between Washington and Beijing. Progress in the negotiations has been slow, and any significant breakthrough looks distant. Under a newly passed law, the United States will now decide each year whether Hong Kong is “sufficiently autonomous” to qualify for special treatment on trade matters.

Any downward turn for buoyant U.S. stocks also would weigh on Hong Kong equities. The cyclically adjusted price-to-earnings ratio developed by economist Robert Shiller, which smooths out the profit for S&P 500 constituents over a decade, has been running at over 30 times. The level was breached only twice before, ahead of the 1929 crash and the dot-com bubble bursting. Likewise, the MSCI Hong Kong Index in late November was trading at a higher multiple of expected earnings than its long-term trend line, according to UBS. Investors will come to rue their risk appetite.

First published Dec. 19, 2019

IMAGE: REUTERS/Jorge Silva