Downward pressure on Hang Seng set to continue

 Alvin Teo Jun Wen

THE Hang Seng Index (HSI) has been falling ever since peaking around the 31,100 region in February 2021. Since then, it has fallen more than 37 per cent and is currently trading below the 21,200 region, the lowest it has been at since March 2020 when the Covid-19 outbreak was declared a pandemic.

The HSI is composed of 62.96 per cent H-shares, red chips and other Hong Kong-listed mainland companies. This means that the current economic conditions of China play a major role in affecting the HSI. As such, with the ongoing negative outlook on the Chinese economy, the HSI has been negatively affected.

China's zero-Covid policy stance has caused a slowdown in its economic output. China's Covid-19 outbreak in March 2022 has resulted in a continued lockdown of many places such as Shanghai, Shenzhen, and Hainan, as the government continues to maintain its strict stance. While countries across the globe are opening up their economy and accepting the reality of living with the virus, China's economy remains relatively closed as it continues its lockdowns and mass-testing. Companies and businesses are forced to shut temporarily, resulting in supply chain disruptions and lower output. This is evident as China's economy only grew by 0.4 per cent for the second quarter of 2022 and was down 2.6 per cent when compared to the first quarter of the year.

Similarly, in Hong Kong borders have been closed since early 2020, as the city follows the Chinese government's zero-Covid strategy. With the borders remaining relatively closed to the rest of the world, exports, investments, and travel-related activities continue to remain sluggish. This has caused Hong Kong's gross domestic product (GDP) to fall by 1.4 per cent in the second quarter of 2022 as compared to the same period last year.

Furthermore, the property crisis in China could further hinder the Chinese economy. Homeowners across 22 cities in China are boycotting loan repayments for their unfinished homes due to delayed housing completion. Property developers are struggling to finance the completion of these projects due to China's "three red lines" policy. The policy is aimed at limiting developers in their liabilities-to-assets, net debt-to-equity, and cash-to-short-term borrowing ratios. As at August 2020, China Evergrande Group, the second largest property developer in China, has become the world's most indebted property developer with about US$300 billion in financial obligations and liabilities. With the huge amount of debt coupled with the drop in property sales, China Evergrande Group is at the brink of collapse. The property sector is one of the significant contributors to the Chinese economy at about 30 per cent of China's GDP. The combination of a lack of confidence in the sector coupled with property developers' struggle to complete current projects and finance new ones will inevitably affect China's GDP.

In July 2022, 6 Chinese property developers including Evergrande and Shimao Group were booted out of the Hang Seng Composite Index as these companies have either sought debt payment extensions or defaulted on their payments. There are still other Chinese property developers that continue to be components of the Hang Seng Composite Index, such as China Res Land, Country Garden and China Overseas Land & Investment, which may continue to drag the Hang Seng Index down.

The Chinese government decided to trim lending rates again in August 2022 with hopes of reviving the economy after its continuous Covid-19 lockdowns and property market crisis. The Chinese government cut its 1-year benchmark lending rate by 5 basis points and its 5-year rate by 15 basis points. That brings the 1-year loan prime rate (LPR) to 3.65 per cent and the 5-year LPR to 4.3 per cent. These monetary easing policies are seen as an attempt to fire up the economy.

The purpose of lowering the prime lending rates is to allow developers to gain access to loans and funding to complete their projects. The Chinese government hopes to regain the confidence of consumers in the property market. In addition, the Chinese government also hopes to revive the economy by boosting investment activities through lower borrowing costs. However, it may not be as effective as the main reason for the property crisis is due to a lack of consumer confidence in the market. Therefore, lower mortgage rates may not translate into higher property sales. In addition, investments may continue to be slow despite lower lending rates as businesses may be afraid to expand, due to the frequent lockdowns under the zero-Covid policy.

With the ongoing problems that China is facing, the HSI may continue to face downward pressures in the near term. Financial results by HSI components have also been disappointing in recent times with many of them missing expectations. According to Refinitiv data, about 40 per cent of the HSI members have reported lower earnings, missing analysts' estimates by 11 per cent. The aforementioned problems that China is facing at the moment have proven to negatively affect businesses as their recent financial results have been disappointing.

Bearish outlook ahead in the near term

There was a double top formation during the period of January 2022 to February 2022, when the HSI was unable to break above the resistance area around the 25,000 region for two consecutive times. The bearish formation was confirmed in late February 2022 when the index broke below the support level at around the 23,400 region which is also the Fibonacci 23.6 per cent level. In addition, there was further confirmation of the bearish formation when the Exponential Moving Average (EMA) 20 line crossed below the EMA 50 line resulting in a bearish crossover.

Subsequently, the HSI began to free fall, dropping over 27 per cent, hitting the 52-week low at around the 18,200 level. The index did manage to rebound towards the 22,400 level which is also the Fibonacci 38.2 per cent level. Recently, over the past 4 months the index has been consolidating around the levels of 19,200 to 22,400 which form the intermediate support and resistance level, respectively.

The resistance level of 22,400 which is in line with the Fibonacci 38.2 level has been tested twice during this period of consolidation. However, the HSI was not able to break above this level. This potentially forms another double top formation which was confirmed when the EMA 20 line crossed below the EMA 50 line in mid-July 2022.

Ever since then, the HSI has been trending below the EMA 20 line where it has failed to close above it after touching the EMA 20 line multiple times during this period. Currently, the index is trading around the support level of 19,200 after falling below the Fibonacci 78.6 per cent level of 19,700.

There may be a wedge pattern forming when connecting the high and low points of the index. This could mean that there may be a potential breakout that may occur in the short term. It is likely that the breakout may be towards the downside. Once the breakout occurs, we may see the index testing the 18,200 level again which will act as the next level of support for the index. This level has been tested multiple times historically during 2011, 2012 and 2016, proving to be a strong support level for the index.

With the ongoing issues that China is facing at the moment such as its Covid-19 lockdowns, property crisis, and increased US-Sino tensions, the HSI will also be significantly affected as a majority of its composite are exposed to the macroeconomic conditions of China. Therefore, in the short term, we foresee the HSI breaking below its 19,200 support level and may test the 18,200 support level again. Any upside, though unlikely in the short term, may see the index testing the Fibonacci 61.8 per cent level of 20,800.  

The writer is equity specialist at Phillip Securities

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