Hong Kong equities are facing mounting pressure amid the escalating US-China trade war and the economic slowdown. The benchmark Hang Seng Index has already slumped over 20 percent from the peak level when trade war started last year.
The price-to-earnings ratio has now fallen back to around 10, the bottom level since 2012. The valuation looks quite attractive compared with historical average.
Historical data over 45 years shows that the Hang Seng Index had rallied 29 percent on average in one year after the P/E ratio fell to 8 to 10 levels. Given this, one might think that the index has a good chance of soaring in the next 12 months from valuation point of view.
However, we should bear in mind that corporate earnings outlook is cloudy. Analysts have kept revising down the average earnings per share (EPS) of Hang Seng Index and MSCI Hong Kong index constituents. And they expect the EPS growth to hover around zero or even fall into negative territory.
The ratio of Hong Kong-listed companies issuing profit warnings out of all earnings guidance releases spiked to 73 percent early this week, the highest level since October 2016. Profitability of listed firms is apparently under great pressure.
Analysts expect EBIT of Hang Seng Index constituents to slump by 19.1 percent this year, the worst decline since the 2008 financial crisis, according to a recent survey by Bloomberg.
On surface, Hong Kong market looks cheap right now, but the case is not true if we consider the downside risk of future earnings.
Based on the ratio of Hong Kong-listed companies issuing profit warnings, which has high correlation with earnings trend, the EPS of Hang Seng Index stocks might tumble 6 to 20 percent.
A large number of listed firms in Hong Kong rely hugely in the mainland China market. Studies have shown that 860 listed firms in Hong Kong generated 90 percent or more of their revenue from the mainland in the last fiscal year. That means Chinese yuan movement will have direct impact on their earnings.
As China’s currency is likely to weaken further, it will also push down the EPS of Hang Seng Index components.
This article appeared in the Hong Kong Economic Journal on Aug 29
Translation by Julie Zhu
[Chinese version 中文版]
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