The economic recovery in the United States has been seemingly robust after years of stimulus measures, while Europe is facing a tougher time in overcoming its woes. Meanwhile, China is managing the expectations for its GDP growth to a more realistic level. Against a global backdrop of uncertainty and volatility, Hong Kong may expect a year of modest growth, says veteran market analyst Peter Churchouse.

By Wilson Lau

The rate of inflation – or deflation – is a key area of economic trends indicating if an economy is overheating or cooling and serves as a benchmark for Federal Reserve officials in their decisions of interest rate adjustment to either stimulate economic activities through a rate reduction or compensate for, among other reasons, too much activity through hikes. It is a fine balance that is sometimes controversial for policymakers because it has a large, direct impact on the prospect of an economy.

The US has arguably the most robust economic recovery among all the developed economies, attributable to US policymakers’ timely and unconventional monetary policies deployed shortly after the financial crisis in 2008. But, rather than inflation, deflation has remained a concern for the country.

“As a result, there is a reasonable chance that the US may not raise its interest rate until later than expected and raise it by less, simply because there’s no inflation happening as of yet,” Peter Churchouse, Chairman of Portwood Capital and Owner of Churchouse Publishing, an authoritative voice in global economic analysis, points out.

US Market Bouncing Back

The US Federal Reserve, currently under the leadership of Chairman Janet Yellen, has repeatedly indicated that it will not increase the interest rate until the US economy picks up. One sign to which economists are looking is the acceleration of wage increase, which has yet to materialize.

Although the US unemployment rate is in decline and creation of new US jobs is at its highest since 2007, nominal wages have shown no sign of increasing while real wages have remained low compared with pre-crisis levels. “If we see wages going up, there will be increasing signals for raising the interest rate,” Churchouse notes.

Despite a range of opinions on the current US equity market, there is no sufficient evidence to support it is in a bubble, Churchouse points out. “It’s just marginally more expensive than the long-term averages,” he says. “If we’re right about the recovering economy and growing earnings, the market will be reasonably robust and maybe the figures are justified.”

“As a safe haven for capital, the US looks more attractive than many other markets right now,” he adds. “When you’re investing in the US equity market, you’re also investing in the US dollar, which is strong when compared with the Euro, Japanese Yen and even the British Pound. Therefore, you’re buying into a recovering economy with potentially recovering earnings.” “Additionally, you’re buying a currency which is likely to remain well-bid,” he further says. “The US equity market will stay strong … yes, there’ll be 7 or 8 percent corrections at some point, but I don’t see a big collapse in the offing.”

Europe’s Long Road to Recovery

By comparison, Europe’s economic recovery is on a rocky road. It’s also difficult to reach a consensus in policymaking among the 19 countries in the economic zone. “The Euro currency experiment is in a dangerous situation,” Churchouse says. “I’ve always been skeptical because it seems impossible to sustain a common currency and interest rate in an environment with substantially different fiscal systems and different regimes of tax, labor, pension and welfare.”

The 10-year government bond yields in many European countries varied significantly before the Euro was introduced, he highlights. Greece’s interest rate, for instance, was around 13 percent while those of Germany or France stood at 5 or 6 percent. “As we got closer to [the introduction of the Euro, interest rates [of the countries] converged,” he points out. “After the Euro came in place, all these countries shared exactly the same interest rate.”



“So, Greece could effectively borrow money at the same rate as Germany,” he explains. “When it blew up after the crisis, we saw the interest rate spread widening again…interest rates in such countries as Italy, Spain, Greece and Portugal went up, while those in France and Germany continued to stay low.”

Interest rates across the Euro zone have started converging again in the midst of quantitative easing. “The risk involved is simply not reflected when Spain and Italy, with low credit ratings by Standard & Poor and Moody’s, can borrow money [at a cheaper rate] than the US,” Churchouse notes. “The European Central Bank is engaged in buying government bonds [as part of QE], but the pricing of government bonds does not reflect the risks of those countries.”


If Greece defaults or walks away from the Euro zone, there are risks with other countries such as Portugal and Spain, he says. “If this happens, the [interest rate] spread will widen again and the risk increases. But if Greece stays and some kind of deal is reached for Greece’s refinancing, then I expect bond yields in Europe to stay low for some time.”

This situation will give rise to a positive environment for three asset classes: bonds, equities, and real estate, similar to what happened in the US. “Just as we’ve seen in the rest of the world with QE, there were record equity markets in the US, Japan and Canada, as well as record bond prices and recovering real estate markets,” Churchouse says. “Financial assets will do well in Europe under this regime. I doubt if the economy will recover quickly, just as it took the US five years to show any signs of recovery.”

European equities are expected to be a boon for investors, particularly because of remaining concerns over currency risks. “As we all tend to be US dollar investors, we’ll look to hedge up the risk of the Euro,” he explains. “For a German pension fund, for instance, it does not matter as the liability will be in Europe anyway. International investors don’t want to see the Euro go down and will hedge up some risks.”

Apart from European equities, long term investment in European real estate, particularly properties in key cities and financial hubs, is equally attractive, he adds. “Interest rate is low and many offer25-year mortgage fixed rate. I’ve started to see recovery in the residential and commercial real estate markets in some cities in Spain and Portugal.”

Overall, Europe’s recovery will be long and painful, Churchouse expects.

“Europe’s economy is just about the same size as that of the US, and the plan to inject 1.5 trillion Euro for the next 18 months through quantitative easing is only a start.”

China Facing Headwinds

China’s ballooning debt level is a major cause for concern. The country embarked on its version of quantitative easing in 2009 following the financial crisis and boosted lending from US$700 billion to US$1.3 trillion in one year. It then carried on and did not stop. The debt to gross domestic product ratio, as a result, has increased drastically.

“The marginal return on every dollar is getting less and less,” Churchouse notes. “Non-performing loans in the banking system are going to rise. But, I don’t foresee the collapse of the big four banks. The interesting thing about China is that the Central Government still has a lot of firepower which it can bring out to bear.”

“These banks have high reserve ratio requirements, some of the highest in the world,” he points out. “The big five banks might be required to raise up to RMB350 billion. It is possible, and I don’t think it will blow up the economy, but there’ll be waves of unsettling bankruptcies affecting the bond and equity markets.”

Another round of stimulus packages is likely, but it will be of a smaller scale and not as encompassing as the previous one, Churchouse predicts. “It will be targeted and specific. It will not go to coal mines, steel mills or aluminum smelters. It’ll go to environmental green technologies, water, agriculture, and food security.”

“We’ll also gradually see capital controls easing over time, which will make it easier for Chinese people and organizations to invest offshore and for foreigners to invest in China,” he says.

Beijing has been trying hard to downplay expectation of growth both domestically and internationally. “In reality, China’s GDP growth was closer to 6 percent than 7.5 percent,” Churchouse remarks. “Power consumption is a big indicator [of growth] and it has been flat. How can there be 7.5 percent growth? The talking down of expectation will continue. 6.5 percent growth is more sustainable from a debt perspective.”

So far, unemployment appears to be a non-issue. In southern China such as Shenzhen, factory owners cannot get sufficient labor, even after the Guangdong government forced factories to raise wages by up to 20 percent.

“There has been a long-standing belief that the economy in China needs to grow at 7 or 7.5 percent to sustain the increase in the number of individuals from the countryside coming to the cities for jobs,” Churchouse says. “That’s not quite true.  But, China’s population is aging and will peak in the next five years.”

Modest Growth in Hong Kong

Churchouse expects Hong Kong’s unemployment rate to edge up in the coming years, given slower economic growth in the city and across China as forecast. Average wages in the city went up by 5 to 6 percent, the highest increase in the world. Together with high asset prices, Hong Kong’s competitiveness has declined. Nevertheless, “2015 will have positive growth but only in the range of around 2.5 percent.”

As far as Hong Kong as a tourist destination is concerned, the number of arrivals from China will remain but spending has gone down because of China’s anti-corruption measures. “We’ll see some growth [in retailing] but growth in the high-teens is not sustainable, maybe 4 or 5 percent,” he says. “That’ll keep the lid on the rents of retail properties and even push them down slightly.”

A mixed, modest year is in predicted for the local finance sector in anticipation of a wave of IPOs of Mainland Chinese companies in the pipeline. “The Chinese government has indicated that it’ll allow these IPOs to come to the market,” Churchouse says. “This is good news for Hong Kong’s professional services providers.”

“The bond market, however, will be a little suppressed as people are worried about the risks in China,” he also points out. “Bond issuance will be a little soft but equity issuance will be good. Private wealth management will be a growth industry in Hong Kong because there’s a massive number of Mainland Chinese waiting to take their money offshore. That’ll be a big growth industry if we have the ability to tap it.”

The commercial office market, particularly in Central, will have a vague recovery in coming years, and the 4 to 5 percent office vacancy in Central Business District will be filled up gradually, Churchouse foresees. The retail rental market, on the other hand, is likely to soften, given a drop in spending by Mainland Chinese. “Purchases of daily necessities are not a problem in terms of demand, but consumption of upper end, consumer durables will be soft,” he notes.

Because the residential market was surprisingly strong in 2014, it’s unlikely that the Hong Kong government will back away from its real estate tightening measures, he adds. “The risk is that it will impose more.”

While inventory is low, the number of new units is increasing year after year. “Hong Kong’s yearly average of long-term private housing production had been 24,000 units but has dropped significantly to less than 10,000 units annually in recent years,” Churchouse points out. “It is expected to slowly pick up to the level of some 16,000 to 17,000 units, which collectively are still below the long-term average.”

“My sense is that we’ll see more supply coming on stream, which may temper the rate of price increase. But, I don’t see anything that will trigger a substantial fall,” he says.

Churchouse also believes the peg between the US and Hong Kong dollars will remain. In fact, Hong Kong remained committed to the peg through six years of deflation and a 60-percent drop in asset prices. “It held its ground because Hong Kong did not have a lot of debt,” he explains. “Even with deflation and unemployment at 7 percent, people and companies were not highly indebted. It did not end up in waves of bank defaults. The situation is still true today.”

It’s also unlikely that the Hong Kong dollar will be linked to a basket of currencies as a way to increase competitiveness, he adds. “Hong Kong companies and people have learned to live with the volatility of asset prices created by the peg. They don’t extend themselves too much as you don’t see massive amount of credit card debt, school loans or hire purchase debt, all of which are common in the US and UK.”

Peter Churchouse, market commentator, analyst and investor in Asia and global markets
Peter Churchouse, market commentator, analyst and investor in Asia and global markets

Peter Churchouse is a widely respected market commentator, analyst and investor in Asia and global markets for more than three decades. He worked for 15 years at Morgan Stanley in Hong Kong and was Head of Asian Real Estate Research, Regional Strategist, and Head of Research for Asia. Churchouse later set up Asia’s first real estate fund, investing in both physical real estate and listed securities. In 2006, his fund was voted “Asia’s Best Real Estate Fund.”

After winding down the fund, he began writing what has now become The Churchouse Letter, one of the few investment newsletters originating from Asia. Members of AmCham Hong Kong can get a 25 percent discount off the annual subscription fee for The Churchouse Letter by accessing the page link at