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3 Types of Stocks to Avoid Amid Hong Kong Protests

Last week, the Hong Kong government enacted a controversial anti-mask law, by invoking century-old emergency powers, in an effort to quell social unrest. It might be too early to say the anti-mask law has failed but with the escalating violence and disruption the weekend following the announcement of the ban, it seems unlikely to quieten down soon.

As the old Chinese saying goes: “A wise man should not stand beside a collapsing wall”. This is particularly relevant to investors in this climate as a few sectors have been hit hard over the past four or five months.

With that in mind, here are three types of stocks in Hong Kong that investors should avoid in the short term given the ongoing political instability.

1. Local luxury retailers

August tourist arrivals plunged 39.1% year-on-year, according to the Hong Kong Tourism Board, and the number of mainland visitors fell even harder by 42.3% during the same month. The Census and Statistics Department also reported a 47.4% year-on-year decrease in total tourist spending.

With luxury goods like jewellery and cosmetics being the main shopping items for mainland visitors, it comes as no surprise that local luxury retailers took the greatest hit in the declining tourism market.

Investors should avoid buying companies that are overly-reliant on the local retail scene. Take the sales distribution below of the three major listed jewellery stocks: Luk Fook Holdings (International) Ltd (SEHK: 590), Chow Tai Fook Jewellery Group Ltd (SEHK: 1929) and Chow Sang Sang Holdings Ltd (SEHK: 0116).

Luk Fook Chow Tai Fook Chow Sang Sang

Mainland China

38% 64%

54%

HK/Macau 62% 36%

46%

Source: Author’s compilation from company reports

Among the three, Chow Tai Fook is least exposed to the Hong Kong market and, therefore, should be less affected by the plunge in local retail sales.

Another example would be the cosmetics chain Sa Sa International Holdings Limited (SEHK: 178). Of its total group sales, 84.7% falls into the Hong Kong & Macau market alone. The company is highly vulnerable given its concentrated market strategy. Given this, there is no other way for the company to see out the storm but to rely on its cash reserves.

SaSa International geographical sales mix

Source: Sa Sa International annual report

Stocks to avoid: Luk Fook, Sa Sa International, Chow Sang Sang

2. Politically-prone companies

A handful of companies have been inadvertently drawn into the recent political tension. The major shareholder of snack store chain Best Mart 360 Holdings Ltd (SEHK: 2360) was accused of having ties with a Fujian gang that attacked protestors in Hong Kong’s North Point district in July.

Since then, its outlets have been boycotted and even vandalised by radical protestors. Similarly, the in-law relationship that exists between the major shareholder of Sa Sa International and the pan-democratic politician Martin Lee has led the company to face a barrage of criticism by Mainland Chinese netizens.

Political risk should not be underestimated. Just last year, the stock price of RUSAL (SEHK: 486) took a nosedive of over 70% when the US Treasury Department imposed sanctions on its major shareholder, effectively putting the company’s operations on indefinite hold. Investors should always carefully examine the background of a company’s major shareholders before deciding to invest.

Stocks to avoid: Best Mart 360, Sa Sa International, Cathay Pacific Airways Ltd (SEHK: 293)

3. Local banks

Coupled with the worsening global economic outlook, Hong Kong could be on the brink of an economic recession. The Hong Kong Purchasing Managers’ Index (PMI) has dropped below 50 for more than a year, indicating a contracting economic growth. Meanwhile, Hong Kong’s Chief Executive, Carrie Lam, said the current economic downturn is worse than that of both the SARS outbreak in 2003 and the Global Financial Crisis in 2008.

Shrinking economic activity would eventually lead to fewer businesses for local banks. If the situation deteriorates, we would see waves of business closures and layoffs.

Default rates would go up, and banks would incur losses. In the worst-case scenario, the loss of confidence in Hong Kong’s capitalist system from the unprecedented social unrest would create shocks to our local banking system as major capital flows out of the city and in search of more stable destinations.

Stocks to avoid: Bank of East Asia Ltd (SEHK: 23), BOC Hong Kong (Holdings) Ltd (SEHK: 2388), Hang Seng Bank (SEHK: 11)

Foolish conclusion

We should not think of the Hang Seng Index (HSI) as a Hong Kong benchmark. As of today, Hong Kong companies only account for a mere 35% of the index, and mainland companies the rest. Effectively, the HSI is a barometer for the economic health of China more than Hong Kong, and hence may not fully reflect the hard time we are facing.

The summer of 2019 in Hong Kong has caught all of us off guard. No one, not even the government, can forecast Hong Kong’s political outlook. Before the economic momentum is back on track, I would advise investors not to buy into the aforementioned stocks, nor make any impulsive decisions purely based on the market performance or political state of the day.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Hong Kong contributor Andy K. doesn’t own shares in any companies mentioned.