HK property stocks – time to shine vs HSI and physical? [Article 2 of 2] 20230531

Now that we have concluded in Part 1 that property stocks will outperform inflation in the next few years, we need to consider whether the larger stock universe, say represented by the Hang Seng Index (HSI) or underlying property could do even better. Here we delve into the relative merits of various peer classes.

We are more bullish on property stocks than the underlying

Deploying similar yield differential study between the HSP and residential property, we can detect four distict turning points in the relative values between HSP and physical: mid 80s and early 2000s stock peaks (red texts) and 1998 and 2022 (ie now) troughs (blue texts) when HSP reached at their cheapest extremes against physical:

Chart 1: HSP yield swings from one extreme to another, we seem to be at the cheap extreme right now

Our technical analysis derived rental yields should see the value go from c.3% now towards 4% handle by 2025, while the extremely high 5-6% returns on HSP should swing the other direction when the huge stock premium (green area in Chart 1) turns into a discount. We project that by end 2024, HSP dividends would still be higher than property rents in yield terms, and likely to trade lower towards the other extreme around 2026 (green arrow in chart).

Property stocks should beat other sectors not holding real assets

The massive tech bubble driven by zero interest rates and QE of the last five years is now over, and we should now see a period of persistent tech underperformance given how the yield relative is at an all-time high (Chart 2). Indeed, the distortion is also the most extreme thanks to covid policies (endless govt handouts and deficit spending while rates were kept at zero). When this valuation anomaly swings the other way, we will see a period of very strong property stock outperformance:

Chart 2: The record dividend difference between HSP and HSI suggests HSP is very under valued

If the yield premium shrinks from the 2% region to -0.75% end (which was the norm during 2003-2015, then some significant outperformance might be in store for the HSP... The current cheapness of physical asset (as represented by high yields in HSP) could be further exacerbated if we consider the new deglobalisation trend where lockdowns and geopolitics may reduce the earnings (and thus returns) of trading/finance related sectors much more than the beaten down property sector.

HSP a safe haven vs govt bonds

At the most liquid end of the peer spectrum, we come to govt bonds as the final leg of analysis for our study. Here the relentless underperformance of the property stock sector (since 2013) reached a peak in 2022 when HSP yields breached 7% (blue line in Chart 3 & 4). However, the reversal in bond yields also began in 2022 when treasury as well as interbank rates spiked the most in the last 40 years, precipitating a reversal in yield premium for HSP vs bonds/bank rates. If this reversal is taken to their respective extremes in the next 3 years or so, we could see HSP also outshine bonds or even deposits...

Chart 3: The HSP yield premium vs US TB should see massive narrowing in coming years

 Chart 4: … similarly for HSP yields against HIBOR

All this could point to a very unusual set of circumstances – in the next two years or so, that despite being rate a sensitive sector, HK property stocks are probably at its most resilient compared to all its main rival asset classes, and could be a real safe haven in the turbulent world we will soon enter, even if we factor in some punchy drops in rents to come in such a chaotic environment, because the prices are pricing in so much distress already...

The author would like to thank Chen Hailan from The University of Hong Kong majoring in Economics and Finance, Leung Kin Tung Sam from The Chinese University of Hong Kong majoring in Quantitative Finance, and Wong Ngai Fung Wallace from The University of Hong Kong majoring in Wealth Management for assisting in data collection, analysis, and drafting this article. 

HK property stocks – is there light at the end of the long tunnel? [Article 1 of 2] 20230502

The Hang Seng Property Index (HSP) has had a rough few years in performance, not only has the benchmark for Hong Kong property stocks massively derated since the peak in 2018, but it is now arguably stuck at a level seen as early as Q4 1996 – which is 27 years ago!

But with the index now loitering at the bottom of its trading range since 2007, and inflation very much returning after a long period of disinflation in the global economy, could an argument be made for investing in the sector again for some inflation hedged outperformance in the coming months or years? We will start by looking at how inflation might pan out in the coming months…

Inflation likely rising higher and for longer

Although benefiting from a strong USD which ameliorated upward price pressures which has been a global phenomenon, inflation in Hong Kong is unlikely to stay too low for much longer, especially now that the world is heading increasingly towards: a) deindustrialisation in the west thanks to zero-carbon madness; b) deglobalisation due to increasing polarisation of the BRICS vs 5-eyes power blocs; and c) continued world war 3 risks which could erupt at any moment – further destroying already badly disrupted supply chains post covid lockdowns.

In this context, we have done a technical analysis derived forecast of HK’s inflation for the next two years, and the result is shown in the red line in Chart 1. As is customary in past inflationary cycles, whenever the CPI rises (red arrows), property as an inflation hedge becomes sought after, resulting in the HSP dividend yield trading at increasing discount to inflation (green arrows):

Chart 1: Base Case market might buy property stocks as inflation hedges, even when they yield 2ppts lower than inflation… 

Chart 2: And in a more extreme scenario, even 5ppts less, should world affairs become more perilous

We believe this pattern will repeat in the coming 2-3 years, resulting in the HSP yield discount to CPI to hit what is quite achievable -2% levels by end-2025 (rightmost green arrow in Chart 1). But given how extreme geopolitical crisis could play out in the near future, perhaps a more pronounced -5% discount might not be out of the question (rightmost green arrow in Chart 2).

To visualise how the yield discount translates to HSP index performance, we have put them on the same chart. One clear pattern that emerges is that the relative yields of property stocks are highly cyclical against underlying inflation, as seen by the multi-year discount-premium swings (green arrows). We are likely on a “premium to discount” run right now, and this may be a big safety factor in favour of property stocks – when inflation rises, market required yields could still hold at their current levels, or at worse, rise by a much smaller magnitude compared to inflation itself, resulting in a potential discount in the coming months:

Chart 3: Possible more than doubling of HSP assuming dividends stayed constant while yields trade at discount to inflation

HSP index as implied in our base case scenario of yields at a 2%-point discount to CPI suggest a possible new all-time high in HSP price in Q1 2025, but having first drop further in the near term (red line above).

So how does index movements (capital return), dividend yields (income return) interact with inflation over the cycles? We have decomposed the total return profile (orange line in Chart 4) into its components – blue area represents dividend yield and green area capital movements, and the main patterns that emerge are:

a) Capital returns are almost always more volatile than both the yield and inflation movements, but tends to move in the same direction as inflation (ie green arrows follow red arrows in Chart 4);

b) Dividend yields on the other end tends to be the more stable element of the three, but also by and large is swayed by the trends in CPI (see magnified view in Chart 5, where blue arrows tend to also follow red arrows):

Chart 4: Capital fluctuation is more pronounced than inflation/dividend yield

Chart 5: Dividend yields likely to rise but may be overtaken by inflation in coming months

To conclude, we think the rightmost blue arrow in Chart 5 will rise as inflation accelerates, but could be overtaken by the latter in the coming 2-3 years, partly also cushioned by the current near record high dividend yields trading in the sector – a good safety margin in deed.

Long cycle of yield premium cycle favours property stocks

The premium-discount oscillation we alluded to in Chart 3 above is represented in a more schematic way in the summary chart below – this suggests that stocks remain cheap as they now stand compared to inflation, and as the pendulum swings to the other extreme (likely reached in 2026), stocks will then be expensive and investors should sell at that time:

Chart 6: Relative value is like a pendulum – swinging from one extreme to the other

Of course, such cycles will vary in both the magnitude (e.g. next cycle could end at the red dotted line of -4.5% or so, or exceed the prior extreme to go beyond -7%) and frequency (so the 9 year time frame that we assumed it will reach the expensive extreme might take more or less in reality). We will obviously assess whether the extreme is reached when we see it, but it is safe to say that at the current levels, stocks are not a high-risk way to hedge against the oncoming inflationary wave.

We will in the next instalment look into whether stocks are a better hedge compared to bonds, or HSI or even physical property by employing similar premium/discount analyses. Watch this space…


The author would like to thank Wong Ngai Fung Wallace from The University of Hong Kong majoring in Wealth Management and Chen Hailan from The University of Hong Kong majoring in Economics and Finance for assisting in data collection, analysis, and drafting this article.

Obesity & Ageing – where to invest for better returns? 20230310

We often hear about the challenges of ageing populations, interspersed with concerned reports about how the developed world is getting fat, with concurrent health problems… But how will these factors impact general economic performance, and along with them, investment returns? This article tries to look into the phenomena in a combined fashion and assess which countries might be potential winners if current trends were to continue…

OECD markets ageing fast, Asia peaking soon…

With the rapid ageing of the working population, the world is faced with not only declining productivity, but also increased healthcare costs. As Chart 1 shows, both Europe and N America have already seen the peak in working population ratios (purple and black lines), suggesting the prime of productivity might be over.

Chart 1: Europe/N America past peak in working age population, Asia still rising into mid 2020s

Asia and S America in the meantime are still on the ascent, with rising proportion of working age population until at least the middle of the current decade. For the most favourable demographics, Africa is the top continent, with no end in sight of the rise in workers in at least the next 30 years…

Viewed another way, the drag on the economies from rising old age is demonstrated below again with Europe having the most severe increases in aged population, rising almost 10ppts between 2020 and 2050 (Chart 2), while Africa will only see less than 3ppts in increase to a still very low absolute figure over the next 30 years:

Chart 2: Europe again heads the table of elderly population, suggesting diminished vibrancy

Older and fatter – not a favourable combination?

Another factor to gauge the economic vibrancy might be how healthy the population is at large. One of the most readily available measure in this regard is the obesity ratio by country – generally the more obese the people are, the more economically stale they may be, and more sickness prone they get. Unfortunately again, the OECD (ie Europe + US) lead the race in high proportion of obese people, as shown in Chart 3 below:

Chart 3: Obesity Rate (BMI>=30) having been rising across the world from 1975-2020 – but OECD leads by big margin

Sadly for Hong Kong, the obesity measures are surging as well, with the proportion of people over 25 on the BMI measure rising from 21% in 2004 to 30% in 2015 (last available data, Chart 4), and even the youngster population cannot escape the fate – where the rise in obesity rate is also alarmingly rapid from 16% to 20% over the same period, Chart 5):

Chart 4: Hong Kong’s adult overweight and obesity rates rose between 2004 and 2015

Chart 5: Hong Kong secondary school student overweight and obesity also surging

Work affected when more are obese

In order to establish whether the level of obesity is indeed a contributing factor to economic performance, we have looked at the pattern in Europe, where there is data for absenteeism and obesity, allowing us to establish whether these two variables are correlated:

Chart 6: obesity seems to correlate with absenteeism from work due to illness (unit: days per employee per year, 2020)

Although further studies may be needed to establish a causality, but a clear correlation exists for the European countries between high obesity rate and number of sick absences. Indeed, this conclusion is supported by other studies, such as the World Obesity Federation’s prediction that economic burden brought by obesity and overweight on the global economy would rise from 2.19% of GDP in 2019 to 3.3% by 2060. 

Avoid old and obese, prefer young and fit countries?

Combining these two variables in typical management consultant 2x2 matrix presentation, we arrive at the spectrum shown in Chart 7 – where:

• the red marks indicate countries with both old and obese populations, which are again mostly OECD countries in Europe/N America;

• while on the opposite end with green marks are countries low in obesity rates and young populations – mostly developing countries in the southern hemisphere;

• between these extremes are old and ‘fit’ populations (orange marks), dominated by developed Asia; and

• finally we have the young but unfit jurisdictions, unsurprisingly mostly Middle Eastern oil states (blue marks)…

Chart 7: avoid red and head for green countries? Or is the obesity a sign of economic success?

While we may have existing state of obesity and age as a measure, perhaps it is more relevant to see the possible trend increase in the coming years for assessing investment return potentials. And with this in mind, we have found the projected future ageing trend as well as obesity trajectories:

Chart 8: Old Age Proportion Increase VS Obesity Rate Increase in 10 years

Again, we can make similar colour based observations as follows:

• the red marks indicate countries with the highest increases in both old and obese populations, here dominated by N America countries with a strong show of the Caribbean states;

• on the opposite end of the spectrum with green marks are mostly East and Nordic European countries;

• between these extremes are ageing fast but ‘staying fit’ populations (orange marks), still dominated by developed Asia.

Perhaps the clearest trend that emerges from the above studies is that OECD countries, especially N America would see the most challenge (subject to the forecasters being correct), while S Asia and East European countries being the more dynamic jurisdictions to head for – both being developing economies. Does this suggest that the age of the emerging economies have finally arrived?

Go East and South…?

The above conclusions, coupled with the record low emerging market equity valuations vs S&P500 (as a proxy for developed market stocks, Chart 9), does make the age-health twin axis look doubly appealing for emerging market investing…

Chart 9: Emerging Market Equities vs S&P500

The author would like to thank Wong Ngai Fung Wallace from The University of Hong Kong majoring in Wealth Management and So Ka Chun from The Chinese University of Hong Kong majoring in Financial Technology for assisting in data collection, analysis, and drafting this article.