The Cheapest Market in the World

In May, as the sheen wore off the European Central Bank's EUR 1 trillion liquidity extravaganza and fresh concerns about Chinese and U.S. growth surfaced, the wheels came off the global rally in risk assets. That reversal has created real opportunity for value-conscious investors who prefer to pay less, not more, for assets. But while strategists and other seers are constantly going on about how cheap U.S. equities are -- which is a matter of legitimate debate -- I have heard very little said about the Hong Kong stock market, which is remarkably, demonstrably cheap.

The number no one is looking at
On what basis do I make this claim? You're right to ask. I've looked at the price-to-earnings (P/E) multiple of the Hang Seng Index, Hong Kong's benchmark index, but not any P/E multiple, mind you.

I constructed a historical series of the P/E10, which uses average trailing-10-year earnings, adjusted for inflation. This is the same methodology that professor Robert Shiller of Yale has championed for the S&P 500 (the P/E10 is sometimes referred to as the Shiller P/E.) Normalizing earnings this way smoothes out some of the noise linked to the business cycle and produces a P/E multiple that has proved to be a good predictor of long-term U.S. equity returns.

A crisis-worthy valuation
Based on Tuesday's closing price, the Hang Seng's P/E10 is 14.0, compared to an average value of 18.6 going back to December 1996. For reference, the index sported a higher valuation than that on nearly 40% of the trading days during the period spanning the fourth quarter of 2008 through the first quarter of 2009 -- the worst of the storm. Imagine being able to go back and buy U.S. stocks at the prevailing valuations during the same period!

In fact, the Hang Seng's P/E10 hit a credit crisis low of 11.1 on March 9, 2009 (if this date rings a bell, it's the same date on which the S&P 500 recorded its lowest closing value). In other words, at the very depths of the credit crisis, the Hang Seng Index was only about 20% cheaper than it is today.

Looking forward... with hindsight
Below is a table that I call the hindsight returns matrix, which shows the distribution of 10-year inflation-adjusted total returns (annualized), conditional on the starting values of the P/E10, which have been split into five ranges (1st quintile: P/E10 values greater than 20.9, 2nd quintile: P/E10 values between 17.2 and 20.9, and so on.) Below the table, I explain how to interpret the results.

I've highlighted the table's fourth row, which corresponds to a P/E10 range of 11.0 to 14.3, since the current multiple is in that range. In the past, that valuation range has been associated with annualized real returns of 5% to 10% two-thirds of the time and returns greater than 10% one-third of the time! Those certainly sound like attractive numbers, particularly in the current environment. I would nonetheless caution readers that the P/E10 and returns series only goes back as far as December 1996 -- much shorter than I would like for this type of analysis.

Two dollars, one peg
Another attractive aspect of the Hong Kong stock market for U.S. investors is minimal currency risk; indeed, the Hong Kong dollar has been pegged to the U.S. dollar for three decades. Investors shouldn't treat a currency peg as a physical constant. Only yesterday, in fact, a former head of the Hong Kong Monetary Authority suggested Hong Kong's central bank should review the policy and consider pegging the currency to China's yuan instead. Still, I think this is no more than a medium-term risk until China makes significantly more progress toward the international acceptance of the yuan.

The best way to get onboard
U.S. investors have a good vehicle with which to get exposure to the Hong Kong market in the iShares MSCI Hong Kong ETF (NYSE: EWH  ) . As an asset allocation-focused investor, I'm more comfortable talking about markets than individual stocks. However, when an index is cheap, it follows that at least some of the stocks that make up that index are cheap also. For stock pickers, I think the area of greatest opportunity is probably financials and real estate.

Cheap, cheap, cheap
Here are five names that I think look attractive, on a first pass, based on a low P/E10 and significant discrepancy between their P/E10 and the price-to-earnings ratio based on the next 12 months' earnings estimate (i.e. they may appear relatively expensive on the basis of estimated earnings, but look relatively cheap on the basis of their earnings power): Cathay Pacific Airways (HKSE: 0293.HK), Cheung Kong Holdings (HKSE: 0001.HK), Henderson Land Development (HKSE: 0012.HK), Sun Hung Kai Properties, and Hutchison Whampoa (HKSE: 0013.HK). Alternatively, you can add international exposure to your portfolio with the three American companies set to dominate the world.

Fool contributor Alex Dumortier holds no position in any company mentioned. Click here to see his holdings and a short bio; you can follow him on LinkedIn. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

Read/Post Comments (17) | Recommend This Article (46)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 14, 2012, at 6:38 PM, constructive wrote:

    Market Trailing PE

    Cyprus 4.4

    Venezuela 4.6

    Kazakhstan 4.8

    Russia 5.3

    Argentina 6.8

    Pakistan 6.9

  • Report this Comment On June 14, 2012, at 6:53 PM, TMFAleph1 wrote:


    The title was a bit hyperbolic -- purposefully. There may well be markets that are cheaper than Hong Kong.

    On the other hand, all of the markets you list above present currency risk (barring Venezuela) and it is impossible to get broad exposure to any of these markets (barring Russia) at a cost comparable to that of the iShares MSCI Hong Kong ETF. (annual fund operating expenses: 0.52%).

  • Report this Comment On June 15, 2012, at 4:52 AM, kickbishopbrenna wrote:

    Cheap? ....for a reason

  • Report this Comment On June 15, 2012, at 5:57 AM, TMFAleph1 wrote:


    A market is always cheap for a reason. The question is whether or not that reason relates to the market's long-term fundamentals and, if it does, whether it justifies the degree to which it is cheap.

  • Report this Comment On June 15, 2012, at 12:35 PM, constructive wrote:

    "all of the markets you list above present currency risk (barring Venezuela)"

    All portfolios have currency risk, and it's not clear that diversification (even into emerging markets) increases currency risk compared to 100% concentration in USD denominated assets.

    In my opinion Venezuela has more currency risk than Russia. They have a fixed exchange rate to the US dollar but the fix could evaporate at any second - as most eventually do.

    "it is impossible to get broad exposure to any of these markets (barring Russia) at a cost comparable to that of the iShares MSCI Hong Kong ETF."

    I wouldn't say it is impossible. If you have access to foreign markets and plenty of money you can construct a low cost basket of securities.

  • Report this Comment On June 15, 2012, at 12:45 PM, portefeuille wrote:

    somehow megashort usually says about what I would have said, had I been willing to say something. I have a suspicion he is European and at least semi-professional (and I think he said so somewhere, my memory is to weak) ...

  • Report this Comment On June 15, 2012, at 1:22 PM, constructive wrote:

    Thanks porte, I consider that a compliment.

    No, I'm an American architect. But I might retire and start a small hedge fund in a few years.

  • Report this Comment On June 15, 2012, at 1:33 PM, portefeuille wrote:

    good idea, give me a call if you need biopharma support.

  • Report this Comment On June 15, 2012, at 1:53 PM, TMFAleph1 wrote:

    Good points, Mega.

  • Report this Comment On June 16, 2012, at 5:41 AM, lwbaum wrote:

    Thanks for discussing Hong Kong. I live in Hong Kong. While I agree that large-cap stocks here are a reasonable long-term investment, I think smaller stocks are cheaper, have higher yields, and thus are better investments. For example, I own six stocks here, with the following market caps, P/E (just for the last year, though), and trailing dividend yield:

    0114 Herald US$60M 4.5 years 11%

    0328 Alco US$160M 4.7 years 13%

    0408 Yip's Chemical US$340M 14 years 5%

    0669 Techtronic US$2.1B 12 years 1%

    0752 Pico Far East US$280M 9 years 6%

    1382 Pacific Textiles US$1B 9 years 10%

    It may be harder to buy such stocks from outside Hong Kong, however, which I think is a major reason that these less liquid (though by no means illiquid) stocks are cheap: less demand from investors but a large supply of companies listed here.

  • Report this Comment On June 20, 2012, at 4:01 AM, gilsh wrote:

    such is life, that when all stock markets look scary, even a market of a land where stock frauds are now known to be a common practice, is once again recommended by an analyst.

    people don't learn.

  • Report this Comment On June 23, 2012, at 4:54 AM, strelna wrote:

    EWH contains a large component of property companies investing not only in HK but also in China and Asia generally. The question about EWH is really whether the property sector is overvalued.

  • Report this Comment On June 27, 2012, at 3:21 PM, Peterktang wrote:

    Of the 5 names you mentioned:

    Sun hung kee-too much uncertainty over the corruption charges facing the top executives.

    Cheung kong and Hutchison- health issues on mr li ka-shing. God bless mr li.

    Cathay pacific- I shy away from airline shares. They are one accident or one terrorist act away.

    Henderson- may be.

  • Report this Comment On July 14, 2012, at 4:30 AM, jfrankh57 wrote:

    My 2 cents: China is often a black hole that sucks money in like no other. Too many "picks" by the Million Dollar Portfolio or Hidden Gems or any other premium advice services from The Fool have ended up losing and some of them lost big, mostly because the ability of the companies in China to use smoke and mirrors or other machanisms to look good without being good on the DIA or the NASDAQ. It is tough to do business with many of these companies that primarily use lies, subterfuge, graft, and bribery to appear solid to the US market.

  • Report this Comment On July 18, 2012, at 8:16 PM, TMFAleph1 wrote:


    'China' and 'Hong Kong' are not fungible concepts.

  • Report this Comment On July 18, 2012, at 8:33 PM, TheDumbMoney2 wrote:


    I think techically, within the U.S. a portfolio of companies: 1) headquarted in the U.S., and 2) which only sell products in the U.S., and 3) which only buy inputs for making those products (or services) that are themselves 4) wholly created in the U.S. 5) using goods and commodities wholly created/mined in the U.S., 6) etc.; and 7) if their consumers are equally not personally-impacted by currency fluctuations, then you could avoid currency risk.

    Of course number 7 is probably impossible, since the macro U.S. economy is to some extent impacted by the U.S. dollar-to-Euro exchange ratio, for example, and so technically you would still not be able to avoid currency risk even in this hypothetical.

    Death, taxes, and risk. Cannot avoid them.

    (And yes, I'm basically just looking for a way to waste a little time here during a lull/break at work.)


  • Report this Comment On July 31, 2012, at 6:20 PM, constructive wrote:


    From an outside perspective, the USD is just another currency. Yes, the market currently regards it as a safe asset and it is my currency (except when I go on vacation). But in the next few decades the market may regard the USD as a riskier asset or I may use more of a different currency.

    So, I regard every asset as having currency risk. I also don't trust the academic theory of Treasuries representing a "risk-free rate". The good news is that currency risk is quite unimportant and not worth worrying about for most equities.

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