The Hang Seng Index’s 0.9% gain yesterday might seem trivial by these days’ standard, but the fact that it occurred right after the Dow plunged 13% in the worst day since 1987 spoke volumes. Amidst this global sell-off, we believe Hong Kong stock market is more defensive than the U.S. market, due to difference in COVID-19 risks, valuations and pressures to unwind positions.
- Valuation of the HSI already priced in a financial crisis. The HSI is trading at 9.3x 2020E P/E, the lowest since the global financial tsunami in 2008. P/B is 1.00x, even lower than the trough in 2008’s financial tsunami, and only slightly higher than the trough in 1998’s Asian financial crisis.
- U.S. equities nowhere near distressed levels. Even after the recent plunge, the S&P 500 is trading at 14.0x 2020E P/E and 2.6x P/B, both are much higher than the troughs in 2008. That suggests the HSI has less downside risks than S&P 500 if investors' worries on the pandemic and global recession persist.
- Investors were much more bullish on U.S. equities than HK / China. Fund managers were heavily overweight on U.S. equities only a month ago, and have been underweight on HK / China for some time. Now that Europe and the U.S. are facing more risks from the COVID-19, the U.S market have more selling pressure from investors who were overweight on them and need to unwind leveraged positions or forced-sell due to fund redemptions.
- Corporate bond yield spread closely watched. When the sell-off in equities will end depend a lot on whether the pandemic will lead to a financial crisis, and that in turn depends on how effectively governments’ infection control measures are. Both the investment grade and high yield US corporate bonds’ yield spread have surged to previous peaks in 2011 & 2016. Whether the spreads would go up much further reflects investors' perception of risks of a financial crisis.
- Opportunities to accumulate H-shares for long-term value investors. We prefer stocks which are less vulnerable to the pandemic and global recession risks, and / or benefit from China’s fiscal stimuli. Construction machinery and 5G telecom equipment makers are key policy-beneficiaries. We also like internet giants.
- Avoid stocks with heavy overseas exposure, including those with significant overseas sales, strong connection with international companies or in global supply chain. We are also wary of devaluation / short-term profit taking on some best-performing sectors in 2019, e.g. property management and sportswear.
