Investors can consider returning to the Hong Kong equity market based on cheap market valuation and favorable fund flows, but they should also consider the immediate geopolitical risks involved in Hong Kong equities, experts say.

In early August, the global equity market experienced considerable turbulence with massive selloffs, attributed to the shifting macroeconomic risks from inflation, and sharp reversals in the interest rate cycle that led to the unwinding of carry trade positions.

The Hong Kong SAR stock market was relatively calm amid this selloff after the market recouped some of its heavy losses from the past four years, with the city’s benchmark Hang Seng Index (HSI) currently trading between 17,000 and 18,000 points, attributed to the inflow of southbound funds and the return of foreign trading investors.

The Hong Kong equity market has reached an attractive level in terms of valuation and fund flow gauges, international fund managers reckon.

“In terms of valuation, Hong Kong-mainland equities are currently trading at the lower end of their historical range which could represent attractive entry points for longer term investors,” said William Fong, head of Hong Kong China Equities at Baring Asset Management (Asia).

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According to Bloomberg data, the Hong Kong stock market is trading at the lowest forward price-to-earnings ratio of 9.3 multiple as of June 21 which represents the highest equity earnings yield of 10.7 percent among the 12 Asia Pacific equity markets.  

In addition, Hong Kong’s bond equity earnings yield ratio (BEER), which measures whether the stock market valuation is expensive or not, has been fluctuating between the multiple of 0.3 and 0.4 based on the average of the trading days during Jan 2015 and June 21, 2024. BEER is determined by dividing the yield of a government bond by the current earnings yield of a stock or stock benchmark. A ratio greater than the multiple of 1 indicates the stock market is overvalued, while a ratio under the multiple of 1 suggests stocks are undervalued.

“For global investors diversifying from US equities, the Hong Kong market stands out as a particularly attractive choice,” according to the research report of Hang Seng Indexes Company.

UBS Investment Bank data showed that southbound inflows into the Hong Kong stock market accelerated to $31 billion into defensive and high yield sectors such as financials, telecom and energy in the second quarter of this year, and it expected southbound inflows are likely to provide support or Hong Kong’s H-shares.

“As Hong Kong-listed shares can offer additional dividend yield and there are concerns around renminbi depreciation, we expect southbound inflows to continue, particularly from the insurance funds which have dividend tax waivers,” argued James Wang, head of China Strategy at UBS Investment Bank.

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Clouded by increasing geopolitical tensions between the Chinese mainland and the United States and market worry over the prospect of the mainland economy, the HSI has tumbled nearly 40 percent over four consecutive years from 2020 to 2023. In January 2024, India’s stock market capitalization overtook Hong Kong’s for the first time as the fourth-biggest global equity market, with the capitalization of the Indian market reaching $4.33 trillion versus $4.29 trillion for Hong Kong, according to data compiled by Bloomberg.

As at Aug 13, the HSI was almost flat from the closing level of 17,023 recorded as at 29 Dec last year. The city equity market staged a strong rebound in the second quarter sparked by a recovery in valuations brought about by risk premium adjustments.

Despite cheap valuation and favorable fund flows, fund managers advise investors to monitor geopolitical risk when considering Hong Kong equity investment.  

Gary Ng, a senior economist at French investment bank Natixis, argued that as the likelihood of a significant improvement in US-China relations has actually always been slim, it is therefore difficult for asset prices to completely shake off previous investment constraints or concerns that investors may harbor regarding tariffs or other geopolitical tensions.

Redmond Wong, Greater China market strategist at Saxo Markets, added: “One of the biggest risks for Hong Kong is whether the US Treasury would impose sanctions on financial institutions in Hong Kong. The good thing is that there are no signs so far that a Trump or Harris presidency will increase this risk.”

CCB International analysts Cliff Zhao and Wilson Zou anticipated HSI will fluctuate with high volatility in the fourth quarter before the index will trade between 17,500 and 22,500 points in the second half of this year, due to uncertainty of the US presidential election result and the pace of the interest rate cut by the US Federal Reserve.  

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“Continued favorable policies, declining risk-free rates, and steady improvement in fundamentals will be needed if the Hong Kong market is to continue to rise,” both analysts argued.

The securities firm recommended investors engage in range-trading following a dumbbell allocation strategy, holding high dividend blue chips and precious metal mining stocks at one end, and gradually shifting to growth stocks such as internet, technology, consumer, and manufacturing with overseas exposure.

Stephanie Leung, chief investment officer at SFC-licensed investment platform StashAway, said investors should take account of fundamental factors when investing in Hong Kong stocks.

“The resilience of global equities, including those in Hong Kong, is rooted in robust economic foundations rather than transient political uncertainties, as we anticipate a resumption of the global manufacturing recovery later in the year which benefits Hong Kong equities, regardless of whether the Trump Trade or a Trump presidency will influence Hong Kong’s economic landscape,” Leung added.