Southbound capital inflows: A one-time phenomenon?

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In the first 1.5 months of 2021, the Hong Kong market was flooded with massive Southbound liquidity, and investors have begun to ask: will the momentum continue? It may look like a simple yes-no question at first glance, but the answer to it is far more complicated than one would imagine.

We must first understand China’s ability to generate foreign exchange reserves in the past year, because the Chinese government will only allow further outflows of foreign exchange if it has a reasonably sufficient amount of it. Secondly, understanding China’s monetary policy is key as an accommodative stance will likely spur southbound inflows. But even if both conditions are fulfilled, it boils down to the appeal of Hong Kong-listed stocks. In other words, mainland investors will not necessarily see Hong Kong as a good enough investment destination if the companies listed in the city are not attractive to begin with.

China’s robust forex reserves growth in 2020

Over the past year or so, China posted strong foreign exchange earnings with Covid-19 having minimal impact on the country’s exports. The Chinese government’s swift move to impose lockdown measures had effectively reined in the outbreak, allowing productions to recover sooner than other countries, which led to a strong export growth. Given the decline in international travel spending among Chinese tourists due to the pandemic, China’s services trade deficit retreated substantially by 42% year-on-year in the first three quarters of 2020[1].

In addition to its record trade surplus, foreign direct investments in China soared last year. This is primarily down to the widening interest rate differentials between China and Western countries, and with the country being one of the handful whose government bonds offer positive real returns, meaning that their bond yields stand above inflation rates, China has been sought after by many bond investors globally. In the first three quarters of 2020, net foreign investment inflows into onshore bond market reached $86.8 billion, a 130% increase compared with the same period last year1.

Overall, given China’s ability to generate forex reserves last year, a substantial inflow of mainland capital into Hong Kong will likely have minimal impact on the size of its foreign exchange reserves.

Are China’s loose monetary policies coming to an end?

Given China’s ample forex reserves, the level of capital flows is to a larger extent a question around the government’s monetary policy.

With China’s financial market lagging that of the US and UK, its monetary policies are implemented using various tools. While interest rate is an important indicator of a country’s monetary policy stance, it is by no means the only factor one should look at when assessing where the Chinese government stands, unlike the US Federal Funds Rate. Fortunately, the People’s Bank of China maintains and updates monthly the total social financing (TSF) data, providing investors insights on capital flows into the economy through bank loans, trust loans, and entrusted loans.

However, the scale of TSF is meaningful only when compared with the size of the real economy. Simply put, a higher growth rate of social financing loans versus that of GDP reflects an increase in hot money circulating in the economy, which will likely drive asset prices to rise.

Over the past year, central banks globally including China adopted loose monetary policies to cushion their economies from the impact of Covid-19. Meanwhile, the growth rate of China’s social financing was almost 10% higher than GDP growth, so the excess capital found its way into the stock markets and were reflected in the performance of onshore equities and the level of southbound trading activities[2].

Looking ahead, we believe China’s monetary policy will remain accommodative over the short term, but money growth relative to GDP growth is expected to moderate this year due to the high base factor, which may interrupt the pace of fund flows into Hong Kong.

The appeal of Hong Kong-listed stocks

Finally, we have to consider the appeal of Hong Kong-listed stocks. While the city’s stock exchange, which in the past was heavily weighted towards traditional industries such as financial services and real estate, was hardly the most vibrant bourse for investors. The Hong Kong stock exchange’s move to relax listings rules has attracted multiple US-listed Chinese tech companies to seek a secondary listing in the city, with many Chinese tech firms continuing to fill the IPO pipeline. Hong Kong-listed stocks, in our view, will be increasingly attractive to both domestic and foreign investors.

Disclaimer

This document is based on management forecasts and reflects prevailing conditions and our views as of this date, all of which are accordingly subject to change. In preparing this document, we have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public sources. All opinions or estimates contained in this document are entirely Zeal Asset Management Limited’s judgment as of the date of this document and are subject to change without notice.

Investments involve risks. Past performance is not indicative of future performance. You may lose part or all of your investment. You should not make an investment decision solely based on this information. Each Fund may have different underlying investments and be exposed to a number of different risk, prior to investing, please read the offering documents of the respective funds for details, including risk factors. If you have any queries, please contact your financial advisor and seek professional advice. This material is issued by Zeal Asset Management Limited and has not been reviewed by the Securities and Futures Commission in Hong Kong.

There can be no assurance that any estimates of future performance of any industry, security or security class discussed in this presentation can be achieved. The portfolio may or may not have current investments in the industry, security or security class discussed. Any reference or inference to a specific industry or company listed herein does not constitute a recommendation to buy, sell, or hold securities of such industry or company. Please be advised that any estimates of future performance of any industry, security or security class discussed are subject to change at any time and are current as of the date of this presentation only. Targets are objectives only and should not be construed as providing any assurance or guarantee as to the results that may be realized in the future from investments in any industry, asset or asset class described herein.

[1] Source: State Administration of Foreign Exchange, as of March 2021

[2] Source: Statistics and Analysis Department of The People’s Bank of China, as of March 2021

Are US growth stocks getting out of hand?

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Over the past four years, the stellar winning streak of US growth stocks has put value stocks to shame. Thanks to the quantitative easing policies the government and the Fed rolled out last year to flood the market with liquidity, and a surge of retail inflows, tech stocks have notched record highs – similar to the elevated levels that precipitated the collapse of the dotcom bubble in 2000. Understandably, retail investors have resorted to online day-trading to ease pandemic boredom, with many of them diving into the market to chase momentum. While the lofty gains have befuddled most investors, some, including professional investors, have begun to wonder: are growth stocks overheated? Is now the time to shift some parts of the portfolio to value stocks?

You have probably heard the story about Joe Kennedy and the shoeshine boy. Just before the Wall Street Crash of 1929, as Joseph Kennedy Sr. got his shoes shined, the shoeshine boy started sharing with the father of the US’s 35th President his take on stocks, prompting Kennedy to realise that the market might have been overheated. Shortly after he sold his entire stock holdings, the market crashed, hard.

In fact, whenever the stock market overheats, it releases all sorts of signals. The question is, however, whether investors are able to catch them and interpret them accurately.

Indeed, it’s not easy to remove oneself from the growth stock-fueled euphoria. Deciphering these signals is already a tough feat, those who are able to act on them in a timely manner like what Joe Kennedy Sr. did are far and few between. As economist John Maynard Keynes once said, “the markets can remain irrational longer than you can remain solvent.”

Through our analysis below, we hope to share with you our views on why the market looks overheated. But we will leave it up to you to decide whether valuations have peaked.

Firstly, some stocks’ valuations have soared to frothy levels. The only way investors can rationalise the sky-high valuations is if they factor future earnings predictions into their analysis. One of the most cited examples is an electric vehicle (EV) maker, which only sold around half a million vehicles last year, and accounted for less than 1% of the global auto market share in 2019[1], [2]. Even so, in this January, its market cap once well exceeded that of the 14 biggest automakers across Europe, US, Japan and Korea combined2. Together, they made up over 86% of the total market share in 2019[3]. There’s no question that this particular EV maker has an innovative vision, and is committed to realising it, but even the greatest company has a limit to which its value can grow. So unless it is going to monopolise the auto industry, we think its current valuation is unsustainable. This, in a way, reflects the state of most growth stocks.

Secondly, speculative stocks have begun to crop up in the market. 480 IPOs took place in the US last year, the highest number in 21 years, of which over 200 went public as SPACs (Special Purpose Acquisition Company), far above year 2019’s figures[4], [5]. So what’s a SPAC? A SPAC is basically a shell corporation, or “blank check” company as some would say. Within two years of a SPAC’s IPO, the sponsor would typically seek to identify potential assets for acquisition. So a SPAC investor has very little idea of what the acquisition target company will be, and at what price. The acquired company can also bypass the registration process that would otherwise be required in a conventional IPO process. Ultimately, the quality of the target company lies in the hands of the company management. So SPACs are in a way slightly speculative, and are considered risky. Last year’s SPAC rush also indicated the enormous amount of money that have been sloshing around in the market. In our view, an expanded risk appetite is a tell-tale sign that the stock market has indeed become frothy.

Thirdly, if we calculate the overall valuations of US stocks using the Buffett indicator, which compares the total value of the stock market to GDP, it has already exceeded the level seen in the dotcom bubble – certainly not reasonably priced at the moment[6].

[1] Source: CNBC, as of Jan 2021

[2] Source: CompaniesMarketCap.com, as of Jan 2021

[3] Source: Autocar, As of Jan 2021

[4] Source: StockAnalysis, as of Jan 2021

[5] Source: Yahoo Finance, as of Jan 2021

[6] Source: Buffett Indicator, as of Jan 2021

Disclaimer

This document is based on management forecasts and reflects prevailing conditions and our views as of this date, all of which are accordingly subject to change. In preparing this document, we have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public sources. All opinions or estimates contained in this document are entirely Zeal Asset Management Limited’s judgment as of the date of this document and are subject to change without notice.

Investments involve risks. Past performance is not indicative of future performance. You may lose part or all of your investment. You should not make an investment decision solely based on this information. Each Fund may have different underlying investments and be exposed to a number of different risk, prior to investing, please read the offering documents of the respective funds for details, including risk factors. If you have any queries, please contact your financial advisor and seek professional advice. This material is issued by Zeal Asset Management Limited and has not been reviewed by the Securities and Futures Commission in Hong Kong.

There can be no assurance that any estimates of future performance of any industry, security or security class discussed in this presentation can be achieved. The portfolio may or may not have current investments in the industry, security or security class discussed. Any reference or inference to a specific industry or company listed herein does not constitute a recommendation to buy, sell, or hold securities of such industry or company. Please be advised that any estimates of future performance of any industry, security or security class discussed are subject to change at any time and are current as of the date of this presentation only. Targets are objectives only and should not be construed as providing any assurance or guarantee as to the results that may be realized in the future from investments in any industry, asset or asset class described herein.