Hong Kong Property: On Some Useful Leading Indicators29 April, 2011, 3:53. Posted by Zarathustra
Tags: Hong Kong, Leading Indicators, Real Estate
Despite having some well-established and consistent relationship, real interest rate is a lagging indicator for how property prices in Hong Kong move. For long time, I put more weight on money supply growth rather than inflation and interest rate in my own forecasts (in fact, some might noticed that I often ignore interest rate for the reasons stated below). Not only is money supply growth closely related to the changes in property prices (at least in the past 10 years or so), but also, mostly importantly, leads the changes in property prices.
Source: Hong Kong Monetary Authority, Centaline
There is good reasons why money supply growth is a leading indicator while real interest rate can only be a concurrent indicator at best (and a lagging indicator at worst, which is the actual reality). Inflation is closely related to money supply. Generally speaking, with higher money supply, general prices level rise. But monetary policy or monetary condition does not have an immediate impact on general price level: general price level increase after increase of money supply. While I can’t tell for how long inflation lags an increase of money supply, it is safe to say that it lags by a few months up to a year (or in the case of Japan, it has never happened).
Also, one have to understand what interest rate is. Interest rate is the cost for a borrower to obtain credit from a lender. The cost of credit is determined by the demand and supply of credit. In general, if the monetary base increase, banks will have more money that they can lend, so supply of credit increases and interest rate will tend to be lower. If the banking system is flooded with liquidity, or money supply increase (well they are not all the same, just for simplicity sake), interest rate will be lowered, generally speaking.
In the case of Hong Kong, if capital flows into the city and drive up the demand for Hong Kong dollar, the Hong Kong Monetary Authority will have to buy US dollar and sell HK dollar to keep the exchange rate stable under the linked-exchange rate system, and that effectively increases monetary base (which is part of money supply). That will translate into lower interest rate in the short term, and higher inflation in the medium term. So there is really little surprise that real interest rate is a very poor indicator for timing property prices movement (if you do insist to use real interest rate to decide how property prices move, you will have to forecast real interest rate one year ahead in order to estimate property prices half a year ahead).
Although I do watch money supply growth quite closely for any indications of property prices movement, it is not perfect. Hong Kong has no capital control, so funds flow can be quite erratic sometimes. For example, despite the trend of increasing money supply in 2006 and 2007, the M1 growth pattern was very erratic, thus it is not easy to make sense of it. In that case, it will be useful to consider both M1 and M2, as M2 seems to be less volatile over time.
Another variable that is generally believed to be predictive of property prices is share prices performance, and in particular, real estate developers’ stock prices. In the case of Hong Kong, the turning points of developers’ stock prices have historically led property prices for around 6 months or so.
In practice, the use of stock prices to predict home prices will always require some caution. For instance, both stock prices and property prices reached the bottom almost simultaneously in early 2009, so stock performance was not a leading indicator in this particular case. Also, stock performance as a leading indicator tends to work only at turning points. Periodic stock out- or under-performance relative to property prices happened all the time and can be deceptive if you read too much into it. For instance, property prices have now been well above the 2008 peak, but the stock price (in this case, Sun Hung Kai Properties) is still way below its peak in 2007. As a result of the stock prices underperformance in 2009, some might be tempted to call a drop in home prices back in 2009. As it turns out, that was a very wrong call. Because of that, I tend to put much more weight on money supply growth than stock prices.
I have warned much earlier that interest rates in Hong Kong do not necessarily move with that of the United States as interest rates in Hong Kong are determined by the monetary condition here, which is very much affected by the funds flow into and out of Hong Kong. Exactly like what I have warned, liquidity is being tightened and major banks have risen mortgage rates twice. As a result, I have turned much more cautious on Hong Kong property last month based on the fact that money supply is not really growing any more (for even more detailed analysis, see Hong Kong Property: Looking Downward). Although I don’t rely too much on stock prices, if one would like to see one more bearish signal, here you go:
Final words of caution: I don’t think any indicators can be 100% reliable till eternity, so one should always be aware of the risk that the past relationship break down in the future.