Risk premiums are set to rise after Moody’s changed their outlook for Hong Kong.
Reverberations in the fixed income market will be felt for some time as traders digest the news and reprice assets.
The equities side of the market actually moved slightly higher since the story broke. This action underscores the advantages of stock based loans for portfolio managers. Investors remain in their positions and get the utility of extra capital to use as they see fit.
The outlook change reiterates a significant correlation between China and Hong Kong. Moody’s phrased it as “high broad-based risk aversion due to asset exposure to China”. The rating agency cited trade relationships and the banking system as areas of concern. Moreover, the “One Country, Two Systems” policy is also under social and political pressure as China seeks to gain more control of the “Special Administrative Region” while some locals hope for the opposite.
Moody’s also indicated, “Hong Kong’s institutions will lose some of their independence over time as China’s economic influence grows. This would negatively affect policy effectiveness and [the] credibility [of] Hong Kong.”
Hong Kong’s financial markets have experienced tremendous volatility thus far in 2016, but the bears seem to be away for now. Stocks are trading at one month highs and volatility is at lows. More specifically, equity volatility on the Hang Seng Index is historically cheap now, in the 28th percentile of its 52-week range.
It remains to be seen if the storm has settled, but Moody’s seems to be taking advantage of the pop in equities to position themselves bearishly for the medium term.
With Hong Kong’s outlook uncertain to bearish for now, investors should be prepared for turbulence. In our opinion, the best way to prepare for uncertainty is to lock in a low interest rate on a stock loan. Credit conditions are stressed, but still liquid and equities have trimmed their losses significantly in the last month. However, markets are on edge because more “unfavorable developments” in China could warrant a larger pull-back and tighter conditions in Hong Kong across asset classes, from real estate to equities and money markets. According, investors should act fast in locking in a rate.
Investors that attempt to time the market with strategic purchases and sales have quantitatively been proven to erode capital. Uncertain economic undertones facilitate volatility, which could tempt managers to trade in order to cover short to medium term liabilities. These scenarios favor patient investors who decide to leverage stock loans. Securitization of your stock had all the benefits of a long position with the added utility a lump sum of cash issuing a bond provides.