Warning signs go overlooked in Hong Kong's hot stock market

The benchmark Hang Seng Index has outpaced peers in all of the world's 20 largest equity markets this year, jumping almost 10 per cent for its best start in over 30 years. PHOTO: EPA-EFE

HONG KONG (BLOOMBERG)- As Hong Kong's booming equity market smashes one record after another, signs of overheating are popping up everywhere.

But good luck finding anyone who's willing to say sell.

"Do not freak out when you see some worrying short-term indicators - fundamentals are still good," said Hao Hong, a strategist at Bocom International Holdings, echoing the advice given by many of his peers in Hong Kong."Who would want to hold cash in such an exuberant market?"

While strong global growth and buoyant corporate earnings have boosted stocks around the world in recent weeks, Hong Kong's rally stands out. The benchmark Hang Seng Index has outpaced peers in all of the world's 20 largest equity markets this year, jumping almost 10 per cent for its best start in more than three decades. A gauge of the city's Chinese stocks was little changed on Wednesday after climbing a record 18 straight days.

The boom is in many ways reminiscent of past market peaks. Measures of momentum, market turnover, analyst sentiment and valuation are all near levels last seen at the end of the Hang Seng's surge in mid-2015, data compiled by Bloomberg shows.

Optimists argue that's no reason to pull out. They note that some indicators have room to rise before reaching their 2015 extremes and that equity valuations in Hong Kong are still well below those in other developed markets. The Hang Seng index could climb another 4.8 per cent by the end of June from Tuesday's close, according to Peter So, co-head of research at CCB International Securities Ltd.

Still, even bulls such as Mr So and Mr Hong say a temporary pullback is possible. Below are some of the indicators that suggest it could come sooner rather than later: Relative strength indices for the Hang Seng and the Hang Seng China Enterprises Index have climbed to the highest levels in more than a decade, far above thresholds that suggest an overbought market. RSIs for the two gauges are also the highest among 70 benchmark indexes tracked by Bloomberg worldwide.

Hong Kong's market turnover jumped to the highest since July 2015 on Tuesday. While trading activity is still below levels seen at the peak of the equity frenzy 2-1/2 years ago, it looks similar to the booms of 2007 and 2015.

The rally has pushed the Hang Seng China Enterprises index to the highest since mid-2015 relative to analysts' share-price targets. The projected 12-month index level in the chart above is derived from the consensus forecasts for stocks that make up the index.

While the Hang Seng and Hang Seng China Enterprises indexes are cheaper than many of their global counterparts, valuations in Hong Kong are catching up. The Hang Seng trades at about 13 times estimated earnings for the next 12 months, the highest level since May 2015.

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