Eric P. Leve, CFA, Chief Investment Officer
September 30, 2019
I spent a week in Hong Kong last month, an almost annual pilgrimage I’ve been making for the past ten years. The tone on the streets was largely unchanged; aside from the weekend disturbances, most Hong Kongers’ daily lives were generally unaffected. The protests garnered headlines (locally, but especially in overseas papers), but remained fairly geographically focused. However, the small proportion of the population affected daily, or the even smaller number that were actively protesting, doesn’t tell the whole story.
The business of Hong Kong is business and that hasn’t changed. But the city-state’s broader environment stands in greater flux than at any time since the 1997 agreement between the U.K. and China to return Hong Kong to Chinese rule. From that time, the policy of “one nation, two systems” has been the guiding principle between the two entities. And, very critically, most of the weekly street protesters are young enough so as to have no memory of life pre-1997. Their perceptions and aspirations for Hong Kong are very different than those of Hong Kong’s current leaders. But now the question is: does the current civil unrest pose a real risk to Hong Kong’s relative sovereignty and to its appeal as an investment destination?
Very critically, most of weekly street protesters are young enough so as to have no memory of life pre-1997.
Hong Kong’s Waning Influence over China
Politically, Hong Kong’s independence has never been assured. At the time of the handover in 1997, Hong Kong got a deal that gave them relative independence for 50 years, through 2047. Realistically, no one expected that life would continue with the same freedoms for 49 years and eleven months and then suddenly fall under Chinese law. But neither did any one expect China’s hand to become so heavy just 20 years in. China definitely struck the wrong chord by pushing for extradition of accused criminals. But something like that is the longer-term reality. Hong Kong protesters’ cries for freer elections of their CEO seem like a pipe dream as that would represent a move away from eventual Chinese rule, not a step toward it.
Hong Kong’s influence with China has waned as the city’s relative economic and financial importance has withered in the past two decades. In 1997, China was a poor country with per capita GDP barely 2.5% of U.S. levels. In contrast, Hong Kong’s per capita GDP stood at 87% of the U.S. in 1997. According to the World Bank, the same numbers as of 2018 show that China rose to 20% of the U.S. and Hong Kong fell to 78%.
Looking at its overall economy over the past 25 years, China has transitioned from an economy only four times larger than Hong Kong to one almost 40 times as large. Hong Kong was a global center of finance, a bridge to the outside world, and a source of prestige for China in 1997. Today China is the world’s second-largest economy, its currency is part of the IMF’s Special Drawing Rights, and its bond and stock markets are now accessible to global investors (its equity market, while not yet included to its full extent in global indices, is the world’s third largest). Clearly, the dog and its tail have traded places and that shift is getting reflected in relative political power, much to the chagrin of free-market, free-thinking Hong Kongers.
Still a Gateway to Asia
While not the golden goose it might have been in the past, Hong Kong remains the premier gateway to Asia for foreign investors. The highly laissez faire nature of its capitalist system continues to garner the top spot in most surveys of economic freedom, well ahead of Singapore (generally in the second spot) and the U.S. (which hovers around tenth). So far the weekends of unrest in the streets have been solely between Hong Kong-based protestors and local police. The Chinese have wisely chosen not to bring out their People’s Liberation Army troops garrisoned in Hong Kong. We believe this is very unlikely to become another Tiananmen Square but, as implied above, the current protests have been a taste of the struggle against inevitable policy convergence over the next generation. So where does that leave investors?
In the short-term, the protests have cast a pall over the market, but will likely have longer-term effects as well. One of the world’s largest e-commerce companies has never had a listing in China despite being based in Hangzhou, China; instead, it made the U.S. its primary market. Earlier this year, the firm considered doing a parallel listing in Hong Kong to diversify its risks as the trade war between China and the U.S. escalated. Then, in August, with the street protests heating up, the firm postponed that decision.
Similarly, Saudi Arabia has been debating where to list shares in its national oil company. The initial candidates (outside of the local Saudi exchange) were Tokyo, U.S., UK, and Hong Kong. The U.S. fell out of consideration due to required disclosures and the risk of asset seizure if Saudi Arabia were to be designated as a sponsor of terrorism. The UK was dropped over the ambiguity around Brexit. Hong Kong, an early front-runner, was ruled out because of the recent and potential long-term risks related to Hong Kong’s relationship with the mainland. In the end, Tokyo is likely to get the listing as the “least-dirty-shirt.”
From a longer-term perspective, Hong Kong has historically benefited as a landing spot for Chinese wealth fleeing the mainland (think the sky-high prices for Hong Kong residential real estate). The appeal of Hong Kong for Chinese workers and capital can only be diminished by even incremental moves to bring Hong Kong’s systems more in line with the mainland’s. Less volatile shores, such as Singapore’s, might see a marginal benefit here.
When I next return to Hong Kong, I expect the trip in from the airport will be easier, but I suspect real changes will be hard to discern. Hong Kong remains a critical symbol for China and so the goose remains golden, if a bit chipped.