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No sign of a quick recovery for Hong Kong

Hong Kong's blue chip Hang Seng Index has crashed below all the support levels which brokers confidently predicted would hold the market, having fallen almost 1,400 points or 9 per cent in the last two trading days.

Although reasons for further pessimism abound, some big Hong Kong investors, such as Mark Mobius, the high-profile president of Templeton Emerging Markets Fund, believe that Hong Kong offers good value at the current lower prices.

Nevertheless most brokers are not prepared to stick their necks out and predict any sudden turnaround. Hong Kong shares may well be trading at giveaway prices, but there is no escaping the market's location in a region which is being deserted in droves by big institutional players.

Moreover, the very liquidity of the Hong Kong market and the fact that it has not lost all the gains made during the past year, make Hong Kong shares the target for sales by fund managers under pressure to raise cash. With investors queuing up to sell their South-east Asian funds, the managers need money to pay for the redemptions.

While this selling pressure lasts, Hong Kong's blue chip index, predominantly traded by institutions, will have a hard time making a recovery. However the rest of the market, which is dominated by local investors, is moving in a different direction.

While blue chips were losing almost 5 per cent of their value last Friday, China-related shares - the so called "red chips" heavily favoured by local investors - shed less than 1 per cent in value. At the same time, the index tracking medium-sized companies fell only 1.5 per cent and the broader all ordinaries index dropped by 3.8 per cent.

In these circumstances, blue chips are in the unusual position of increasingly trading at a discount to the rest of the market. Cheung Kong, the flagship company of Li Ka-shing, Hong Kong's most influential businessman, is now trading on a price/earnings ratio of under 14. This is fraction of the valuation placed on most leading red chip companies, which would seem to reflect confidence that these groups will weather current storms.

Determined optimists may also take heart from the banking cartel's decision last Friday not to raise interest rates. The high level of overnight rates, caused by occasional pressure on the Hong Kong dollar, could have triggered a general rise in interest rates. However, while other Asian currencies have tumbled, the Hong Kong dollar has managed to preserve its fixed link with the US dollar without much fluctuation.

The aggressive market activities of the Hong Kong Monetary Authority have maintained this stability, but at a price in interest rate terms: on some days the overnight interbank rate, at which banks borrow from each other, has exceeded the rate of interest they are earning from prime customers.