Turmoil in Hong Kong’s streets and markets worries investors

Hong Kong’s financial markets are in one of their most volatile periods in years, and signs of a turnaround are few and far between.

A brief rebound in stocks is fading as concern grows over the impact the trade war, political unrest and a weak yuan are having on corporate earnings and the economy. Investors pulling funds from the city would undermine the local dollar and potentially force the central bank to defend the peg. That would tighten liquidity, spike interest rates and pressure a fragile property market.

Hong Kong stands out even as markets worldwide are dragged down by a deterioration in growth. With no obvious end in sight to anti-government demonstrations, the local dollar is returning toward the weak end of its trading band and the Hang Seng Index has lost nearly 9% since the end of June, on course for its worst quarter in four years.

“It’s still too early to call the bottom,” said Raymond Chen, a portfolio manager with Keywise Capital Management (HK) Ltd. in Beijing. “The local incident looks far from being resolved. We’d stay cautious about putting money in the Hong Kong market.”

There’s been some encouragement. Hong Kong equities are proving popular with investors from mainland China, attracted by their lowest valuations since late 2016. They funneled a net $7 billion across the border over 25 consecutive sessions through Thursday, though trading via exchange links accounted for only about 11% of daily turnover in the city’s equities during that period.

Calm is also returning to the options market, where the price of bearish puts on the Hang Seng Index has dropped versus the cost of bullish calls in the past two weeks. That shows there’s less demand to hedge against further declines in the gauge. The spread, known as skew, spiked to a one-year high on Aug. 6.

Tim Nan, chief investment officer of Nanjing Hilltop Investment Management Co., has added more Hong Kong-listed Chinese firms in his portfolio.

“The core value of Hong Kong is that it functions as a transit for China’s economy and the domestic financial system, and I don’t think the conflicts are going to change that,” Nan said. “Since that core value remains unharmed and quality stocks are getting cheaper, why not buy on the dips?”

But the protests are a big overhang, at times bringing parts of the city — including the international airport — to a standstill and clouding the economic outlook. Financial Secretary Paul Chan said gross domestic product will grow 0% to 1% this year, down from a previous forecast of 2% to 3%. China is also pushing the development of Shenzhen, including possibly granting it privileges in yuan internationalization, a potential threat to Hong Kong as the offshore center.

“Stocks may have largely priced in the local incidents, but it’s hard to gauge the ramifications in the medium to long run, including whether China’s development plan for Shenzhen is aimed at replacing Hong Kong,” said Ronald Wan, chief executive of Partners Capital International Ltd.

Wan is watching how trade talks between China and the U.S. evolve in the coming months, as well as corporate earnings. The impact from protests, which kicked into high gear in early June, on local tourism and consumption hasn’t yet been reflected in corporate results, he said. “It may only start to bite in the second half.“

Most Hong Kong retailers have seen sales drop more than 50% in August, the city’s Retail Management Association said Thursday, urging landlords to halve rents for six months to help tenants through difficult times. The value of retail sales dropped for a fifth straight month in June, official numbers show.

Morgan Stanley warned this week that the Hang Seng Index could drop to 21,500 points given the “current environment” and investors should “remain defensively positioned and sell near term rallies.” That level would signal a bear market as it implies more than 20% downside from an April peak. The benchmark was up 0.2% as of 10:26 a.m. local time at 26,095.15.