Is The Hang Seng Index A Falling Knife?

This Article was first published on 30th Nov 2018 on our Asia-In-Focus Newsletter. To get the latest newsletters, click here.


Nov 2018 Edition

Is The Hang Seng Index A Falling Knife?

Among all the major stock markets around the world, the Hang Seng Index would have to be among one of the worst performers this year.

Source: Google Finance – Hang Seng Index YTD Performance

The Hang Seng Index is the key stock market index for the Hong Kong market. It is a market-capitalisation-weighted index of the top 50 companies listed on the Hong Kong Stock Exchange.

Even though the index tracks not just some of the largest companies in Hong Kong, many of the largest China mainland-based companies are represented by the index as well. Yet the index has fallen close to 25% this year, from a peak of about 32,700 points to low of about 24,700 points at the end of October.

By contrast, the S&P 500 Index (US), Straits Times Index (Singapore) and the Kuala Lumpur Composite Index (Malaysia), have fallen around 10% to 15% each from its peak to trough year to date.

What has contributed to the decline?
The Hang Seng Index is made up of the performance of 50 companies, however, the weightage between them varies depending on their market capitalisation and free-float.

The current list of 50 companies within the Index includes:

Stock Name Weighting %
HSBC Holdings 10.26%
Tencent Holdings 9.70%
AIA Group 8.86%
China Construction Bank 8.20%
China Mobile 5.41%
Ping An Insurance 4.81%
ICBC 4.67%
Bank of China 3.12%
Hong Kong Exchanges and Clearing 3.09%
CNOOC 2.59%
CK Hutchison Holdings 2.55%
CLP Holdings 1.92%
China Petroleum and Chemical 1.91%
Link REIT 1.82%
Hong Kong and China Gas 1.66%
Sun Hung Kai Properties 1.66%
CK Asset Holdings 1.64%
Hang Seng Bank 1.58%
China Life Insurance 1.41%
Galaxy Entertainment 1.36%
PetroChina 1.29%
BOC Hong Kong 1.28%
China Overseas Land and Investment 1.17%
Geely Auto 0.95%
Sands China 0.94%
China Resources Land 0.91%
Power Assets Holdings 0.86%
CITIC 0.83%
Country Garden 0.81%
Shenzhou Intl 0.81%
China Mengniu Dairy 0.75%
CSPC Pharma 0.75%
New World Development 0.74%
MTR Corporation 0.69%
China Shenhua Energy 0.68%
Wharf Real Estate Investment 0.68%
Sunny Optical 0.63%
China Unicom 0.62%
Bank of Communications 0.59%
Henderson Land Development 0.59%
WH Group 0.59%
Sino Biopharmaceutical Ltd. 0.58%
Hengan International 0.53%
Swire Pacific A 0.49%
AAC Technologies Holdings 0.47%
Cheung Kong Infrastructure Holdings 0.45%
Sino Land 0.44%
Want Want China 0.37%
Hang Lung Properties 0.35%
China Resources Power 0.33%

Source: Hang Seng Index ETF (2833. HK)

Although we can see that there are 50 companies within the index, the majority of the weightage is still concentrated in the top 10 companies.

Source: Hang Seng Index ETF (2833. HK)

In fact, the top 10 companies in the index now contribute more than 60% of the weightage. We can also see that this top list is dominated by companies in a few industries, namely;

  • Financial (43% of Index)
    • International Bank, HSBC Holdings
    • Insurers, AIA Group & Ping An Insurance
    • The three Chinese Banks
    • Hong Kong Exchange & Clearing Ltd
  • Technology (9.7% of Index)
    • Tencent Holdings
  • Telecommunication (5.4% of Index)
    • China Mobile
  • Oil and Gas (2.6% of Index)
    • CNOOC

And these are the companies that have been suffering the majority of the decline, with banks like ICBC or Bank of China falling more than 20%. Technology giant, Tencent Holdings, dropped close to 50% from its peak this year. Analysts have contributed the fall to reasons such as the China and US trade war, the risk of the deleveraging happening in the Chinese financial system and even company-specific issue with game restriction facing Tencent Holdings.

However, what all these pessimism also brought us is the low valuation within the Hong Kong market that investors have not seen for many years.

Which Will You Pick?
Let’s compare how the valuation of some of its companies stack up against international peers.

Source: Morningstar

Apart from Tencent Holdings and HSBC Holdings, most of the Chinese banks and its telecommunication company are trading significantly below its peers in the Singapore and Malaysia markets.

Yet if we compare the market potential with these companies and its Southeast Asia peers, it is quite clear that the Chinese-based companies have so much more growth potential. Then it bets the questions, should these Chinese blue-chip stocks be trading cheaper than its Southeast Asian peers?

To me, it does not make a lot of sense. Of course, that is not to say that the market would magically rebound just from this point onwards. To give you a sense of the worst case possibility, the Hang Seng Index dropped close to 60% during the 2008 financial crisis before recovering.

Plus there are some real issue and challenges facing these companies in the coming years. Thus, there is definitively risks involved and it is associated with the macro-risk of the entire Chinese economy, to see if it is able to transform from an export-led economy to only that is consumption-based.

However, many of the Southeast Asian economies are so connected to the Chinese market, it means that if China is to have a crisis, companies in Southeast Asia would most likely be affected as well. And if we are all exposed to the same risks, should I be betting on the companies that have better valuation and yet offers me a larger growth potential?

Which is probably why I have been investing more and more into the Hong Kong market recently.

Till next month, invest Safely,
Stanley Lim
Chief Editor

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