Hong Kong Here We Come!

Turning positive on Hong Kong market with low conviction

I am Qi Wang, CEO of MegaTrust Investment (HK), a boutique China fund manager based in Shanghai and Hong Kong. Total 25 years of experience in Chinese and global equities. This is my blog for MegaTrust clients and professional investors. If you’d like to learn about China from a practitioner’s point of view, this is the right newsletter for you.

Technical Correction Ended

First, a revisit to my earlier post on the Hong Kong stock market, which offered a cautious view on the Hang Seng Index.

“Our analysis suggests a possible 10-18% downside to Hang Seng Index near-term. This implies an index level of 18,614 to 20,431 in the next two months or so, based on the January 27 high.” Daily Reflection on China, January 31, 2023

Since then, Hang Seng dropped to a low of 19,132, and closed at 19,519 on March 17, right in the middle of my forecast range. Based on the same model, this is the end of the “technical correction” following the relief rally beginning November 2022. How the index trades from here is anybody’s guess.

Not sure if this has to do with the current market collapse. The China / Hong Kong bulls from earlier this year have largely disappeared. The so-called market pundits are only good at cheerleading the stocks when prices are up, and giving you warnings when stocks are down. That job can be easily taken over by ChatGPT now.

I recently wrote a three-part series on the key risks of investing in China and Hong Kong this year. The good news is that the Chinese economy is finally showing signs of a recovery. The bad news is that geopolitical risk, specifically the relationship between China and the West, is the number one overhang on Hong Kong stocks right now. My recent interaction with Washington Analysis and several global investors confirmed this thinking.

To this end, I am hopeful of President Xi’s visit to Russia next week, as a way to further clarify China’s position on the Russia-Ukraine war, and perhaps move one step closer to a peace agreement. China just ended 40+ years of hostility between Saudi Arabia and Iran. Could China also engineer a possible end to the Russia-Ukraine war? Never say never. If China can play a pivotal role here, not only there will be peace, China’s diplomatic predicament will also be greatly reduced. The Hong Kong market could see a sustained rally from there.

Low Conviction is OK

I am positive on the Hong Kong market, but my view also has a low conviction …and that’s…OK (Stuart Smalley, SNL).

No one really understands all that’s going on right now, Russia-Ukraine, U.S.-China, global economy, the Fed, Silicon Valley Bank, ChatGPT, Prince Harry and Meghan…

As a stock picker, my natural inclination is bottom-up, focusing on the company fundamentals and thinking that the micros would overcome the macros. In normal times, a good stock pick should defy the macro risks. But today’s macro environment is anything but normal. At this juncture, I don’t think any companies can fully defend themselves against the onslaught of top-down risks.

This is not to suggest we give up the high conviction ideas. Just that we need to narrow them down to things that we really have the edge and ultra-high conviction. Best of the best. Top of the pyramid.

As for the rest, there is nothing wrong with having low or no conviction at all, going with the flow and trading more frequently. If my previous portfolio mix was 80% strategic (high conviction) and 20% tactical (low conviction), the new mix is around 50/50. If my previous portfolio turnover was 20%, today it’s something like 40%.

Call me an opportunist. Opportunism is exactly what it takes to survive in this market.

Hong Kong Reopening Index

One theme that we have ultra-high conviction on is the reopening of Hong Kong and Macau. Here is why:

1. We are based in Hong Kong.

2. Both cities are relatively small and easy for us to track. Macau has about 680,000 residents and an area of 32.9 sq. km (12.7 sq. miles). Hong Kong has a population of 7.7 million which seems a lot but still small compared to Shanghai and Beijing.

3. In terms of the economic policy, both cities run independently from the central government. Thus less intervention or interference from Beijing.

4. The Hong Kong government remains quite business friendly. And despite the controversial relationship with Beijing, Hong Kong is still more competitive than any other Chinese cities on the global stage.

5. Hong Kong’s rising strategic importance as China’s precious window to the world.

6. Macau’s scarcity value as Asia’s only world-class gambling destination. Southeast Asia alone has over 680 million people, with a growing middle class and the consumption upgrade. (Macau is also known as the Las Vegas of Asia, but honestly, I think Las Vegas should be called “Macau of the Americas”).

The latest data also support our investment thesis:

• Macau visitors surpassed 80,000 daily in mid-February (after the Chinese New Year), which has recovered to 74% of the 2019 pre-covid level.

• Hong Kong visitors climbed to around 75,000 daily during March 6-12, which has recovered to 47% of the pre-covid level.

• Hong Kong retail sales was up 7% yoy in January 2023, and recovered to 75% of the January 2019 level, as the Hong Kong-mainland China border reopened. Goldman Sachs expects a more “meaningful” recovery in February, given the end of the mask mandate and new consumption vouchers.

• Hong Kong’s unemployment fell to 3.3% between December 2022 and February 2023, a new historical low. Labor shortage begins to surface in travel, leisure and hospitality industries.

• Go to any online travel booking site, you’ll find Hong Kong and Macau hotel rates up multiple times from the 2022 trough. A three star hotel in Hong Kong’s city center easily sells for USD 200 a night these days.

• The Hong Kong Rugby Sevens (March 31 - April 2) is the next thing to watch for the global business and travel interest in Hong Kong.

For an introduction to our Hong Kong Reopening Index, please click here.

As of March 17, 2023, the Index is down 1.5% YTD, versus a 4.4% decline of the MSCI Hong Kong Index, and a 1.3% decline of the Hang Seng Index. As a reminder, the Reopening Index contains 39 local Hong Kong stocks, spanning over five sectors: Consumer Staples, Consumer Discretionary, Industrials (Transportation), Real Estate and Financials.

Separately, we also started a model portfolio called Hong Kong Reopening Select Index. The objective is to use stock selection to generate additional Alpha over the passive Reopening Index. The Select Index contains 13 stocks currently, and is down 0.96% YTD, beating in the MSCI Hong Kong Index by 3.44%.

We will provide more details on both indices in our next post, the passive index and the stock selection index. Paid subscribers can request further details including portfolio holdings by email (anson.chau@megatrust.com.hk). Free subscribers please upgrade to the paid subscription in order to receive regular portfolio updates.

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