A Bottom for Hong Kong?

The market is trading at global crisis levels and below most Asian valuations.

As Hong Kong stocks slip deeper into a bear market, there are signs the rout is overdone. The Hang Seng Index, which has dropped about 22 percent in the past 12 months, is now the cheapest in Asia by dividend yield and price/earnings ratio.

Whether investors are seeing buy signals could depend more on their views on China's economy and U.S. interest rates than on standard metrics, but if history is any guide, stocks may be near bottom.

Even after a rally Thursday and early Friday, the Hang Seng has a dividend yield of 4.49 percent and a P/E of 8.40 times. That payout level puts the city's stocks behind only Singapore, Australia and New Zealand among major Asia-Pacific indexes. By earnings multiple, Hong Kong is last in the list, trailing even Karachi. The P/E has been lower on only 15 days in the past six years -- five this year and the other 10 in June and July 2011, when concern of a potential Greek exit from the euro coincided with the risk of a government shutdown in the U.S. and a probe into the accounts of China's Sino Forest.

Cheapest in Asia

Hong Kong's dividend yield is only behind Singapore's and New Zealand's and the P/E ratio is the lowest

The index would have to drop 8.8 percent from the Feb. 4 losing level to reach the 2011 low in the P/E. Meanwhile, if it were to return to its 10.4 times five-year average, the market would rally 24.4 percent. So based on recent history, the Hang Seng's upside potential is almost three times higher than the reverse. The danger is that instead of testing 2011 lows, Hong Kong could plumb depths not seen since 2009. Yet, excluding the global financial crisis of 2008-09, the Hang Seng's P/E hasn't consistently been this low since the Asian financial crisis of 1997-98.

Rare Value

Since 2009, the Hang Seng Index has only been cheaper for a short period in 2011, amid Grexit fears

A technical indicator that has been reliable in the past is the proportion of companies in the index trading at 52-week lows. In late January this reached more than 60 percent, again the highest level since 2008.

High Returns

The estimated payout from buying stocks in Hong Kong is at a six-year high

The hurdle for the oversold argument is China. The easiest way for international investors to express a bearish view on the world's second-largest economy is by shorting Hong Kong. Since June 30, 2015, the correlation between short-selling turnover for the Hang Seng and the Shanghai Stock Exchange composite indexes has been stubbornly negative, at a level that implies global investors are using the open market off China's mainland to register their disappointment in Beijing's policies. The index has also mostly been moving out of step with the S&P 500, which used to help determine its direction in the past.

Short-selling turnover in Hong Kong has dropped to only 7.2 percent above its five-year average, suggesting bearish sentiment has subsided. Sounds like Warren Buffett territory. 

In an op-ed in the New York Times weeks after Lehman Brothers collapsed, Buffett wrote: "Be fearful when others are greedy, and be greedy when others are fearful." Last September, the sage of Omaha told Bloomberg he was bullish on China.

Since that interview, the Shanghai Composite is down about 14 percent. In that New York Times piece, Buffett reminded readers that he doesn't watch short-term movements, focusing instead on where companies will be five, 10 and 20 years from now. It's hard to think Hong Kong will be much worse off by then: a point for brave investors to ponder. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    Christopher Langner in Singapore at clangner@bloomberg.net

    To contact the editor responsible for this story:
    Paul Sillitoe at psillitoe@bloomberg.net

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