Meet a Hong Kong Skeptic

How long will the rally last?

The euphoric sentiment of the past few weeks is directly related to the handover and not to fundamentals. It can't last forever. The key is Hong Kong's position in its economic cycle -- which is precarious. Consider two foundations of Hong Kong's upswing: first, the U.S. economy's rally is aging. Second, authorities in China want to lower interest rates to stimulate the economy and help state enterprises out of an incredible mess. At the same time, you have foreign investment pouring in as everyone dreams about selling to a billion Chinese. On top of that, capital spending in China has slowed, and you have all this liquidity. That is fueling the financial markets in both China and Hong Kong.

Will politics be a concern after the handover?

I really don't think so. The idea that China is coming down hard with nefarious intent is a red herring. The real risk to Hong Kong comes not from China but from itself. In corporate takeovers, smaller company executives often divert their attention to second-guessing what their new parent wants. But Hong Kong people would be wasting their time guessing rather than getting on with their jobs.

Is there a property bubble in Hong Kong?

Property prices have gone through the roof in the past 18 months. But it is not yet a bubble of excessive proportions. I do think prices have gone too high. And not just in property. Every day, I watch people queue up for the issue of some new red chip [Hong Kong listed companies with strong mainland connections]. If you had said in June 1989 after Tiananmen -- "China is fantastic and Hong Kong will be vastly better off after the handover" -- you would have been clobbered. Today, it is just the opposite. In June 1989, the Hang Seng Index was 2,200; today it is 15,000. These are two extreme examples of excess.

Do you expect Hong Kong's U.S. dollar peg to stay?

I expect the Chinese to stick to it doggedly. Everyone repeats the mantra: "The peg is in the best interests of Hong Kong, China and the world." But you don't have to look farther than Thailand to see what happens when a peg goes wrong. When you have a fixed exchange rate, interest rates are directly impacted by capital flows. If capital pours into Hong Kong, interest rates go down. But when capital is flowing out, there is no upper limit on rates. Hong Kong investors in the property market are driving prices like they're in a Formula One race. An increase in interest rates could be devastating.

Do you see U.S. interest rates rising soon?

Definitely. I expect rates to increase at least 0.5% within the next few months. And there might well be more increases toward the end of the year. Because of the peg, rate increases in America would mean similar increases in Hong Kong. That would start to deflate the bubble.

What do you make of the red chip mania?

Absolutely incredible. How high will the fireworks go? I don't know. I don't think anyone can show me the fundamentals. I don't buy the story that these red chips are being given dirt cheap mainland assets for the benefit of Hong Kong shareholders. There is no such thing as a free lunch.

Which sectors look attractive and which don't?

One must be wary of these queues of people lining up to buy new issues. Don't get me wrong, this euphoria could very well continue, and we may see new records for the Hang Seng before it is over. But I should point out that all the major sectors are overvalued at current levels. Certainly, I'd avoid property stocks. The banking sector is another one to stay away from. I can't believe Hang Seng Bank is trading at 53% of its gross assets. That's extraordinary. Conglomerates are probably a better value than some other stocks. It is really difficult to find cheap stocks in Hong Kong, but not impossible. Peregrine Investment is a Hong Kong investment bank with major exposure regionwide. As other regional markets start to do better, Peregrine should do well.