Can the Sneak Rally in Hong Kong, Asia’s Top Performer, Continue?

Hong Kong stocks are shooting higher Thursday, adding to a sudden rally that makes them Asia’s top performers over the course of the last month.

The benchmark Hang Seng Index is up 1.6% on Thursday, taking its gains since the rally began on April 19 to a whopping 19.4%.

So has a serial underperformer, often the world’s worst major market over the course of four downward years, finally turned the tide?

Thursday’s rally is particularly pronounced because flat-lining China property stocks are gasping new life. The spark has been reports that Beijing plans to direct local governments to buy unsold homes from distressed developers. That kind of commitment would go a long way toward restoring confidence in the sector.

Mainland developer Longfor Group LGFRY (HK:0960) led the Hang Seng for gains, adding 10.9% Thursday. That takes its advance since April 19 to an eye-popping 51.6%.

The Hang Seng Properties Index has doubled the broader Hong Kong market Thursday, with a 3.1% advance. It is the mainland listings rather than Hong Kong-focused developers leading the way.

Garden Services (HK:6098), the property-management arm of what was China’s largest developer by sales before it ran into financial trouble, is up 5.8% Thursday. Shares in the developer Country Garden Holdings CTRYY (HK:2007) itself are suspended after it postponed the release of its 2023 results, with the company facing a winding-up order in Hong Kong from creditors.

Many of the largest Chinese developers list their shares in Hong Kong rather than the mainland to attract international investors. But the death spiral in mainland property sales and prices has caused a total loss of consumer confidence in the sector. And that in turn has reduced the bulk of the China developer stocks to penny shares.

State-backed China Vanke CHVKY (HK:2202) saw its shares gain 16.0% on Thursday in Hong Kong. Like Country Garden, it had been regarded as a better-managed developer but has also run short of cash due to plunging sales.

The rally is also particularly pronounced Thursday because the Hong Kong market was closed for a holiday on Wednesday in honor of Buddha’s Birthday. South Korean stocks also took a break from trading on Wednesday in honor of the Buddha.

The State Council in mainland China is reportedly getting feedback on a preliminary plan to direct provinces and city governments to buy unsold homes. Bloomberg first reported the discussions on Wednesday, leading to a rally in mainland property listings, which are very hard for international investors to access.

Chinese Communist Party officials met in April to discuss ways to clear the mounting inventory of unsold homes. However, many local governments are also short on financing because they have typically relied on land sales to developers for the lion’s share of their revenues. Provinces and cities are also still reeling under the cost of the very expensive and extensive but ultimately futile effort to wipe out Covid-19 in China.

We’ve been fooled by Hong Kong rallies before. As it became clear the Covid-19 crisis was nearing an end, the Hang Seng rallied 27.1% between the start of November 2020 and mid-February 2021.

Then it began to slide again … by October 2022 the Hong Kong market had lost half its value, down a staggering 47.1%, leaving local stocks below their Covid lows. As of mid-January, you would have been nursing a loss on Hong Kong stocks bought at the start of this century.

Hong Kong has been trapped between a sluggish Chinese economy and a rampant, high-yielding U.S. dollar. The Hong Kong dollar is pegged at HK$7.78 to the U.S. dollar, meaning the city effectively “imports” U.S. interest rates, even though the local and mainland economies were not justifying high rates.

The prospect of easing U.S. interest rates should stimulate the Hong Kong stock market. But when U.S. central-bank easing will come has been pushed and pushed out into the future, undermining any investors who tried to front-run the move by buying Hong Kong stocks.

But easing U.S. inflation is already putting air under the wings of the Hong Kong market. This lift-off may manage to stay in the air if there’s really a solution to the property crisis in China, the most-important sector, at around one-quarter of total Gross Domestic Product.

Local state-owned enterprises would be directed to buy unsold homes from troubled developers at steep discounts, using cheap loans from state banks, according to the report. Many of those homes would then be converted to affordable housing.

It was the Beijing government that precipitated the housing crisis, by attempting to force deleveraging on the sector with the introduction of the “Three Red Lines” on credit and borrowing in August 2020. Robbing the property industry of its practice of selling apartments off-plan and using deposits to fund construction as well as future land purchases meat the sector soon ran aground.

There have been piecemeal efforts to solve the loss of confidence in the sector, but none have made much of a dent. Beijing is also cautious about offering easy credit to homebuyers, for fear of sparking a rapid rise in speculation and property prices.

Major cities such as Hangzhou and Xian have recently scrapped restrictions on home purchases in a bid to boost sales. But it is optimism about a broader central-government solution that has driven property stocks up since an April 19 low.

We should await confirmation of the plan before knowing for sure that the Hong Kong rally is for real. Meantime, developers in default such as Sino-Ocean Group Holding SIOLY (HK:3377) are seeing significant speculative buying, the penny shares up 46.2% Thursday, and now more than double their April 19 low.