The secrets to being a successful Hong Kong investor:

1. Find a small, obscure stock.
2. Slowly accumulate a position in the stock.
3. Compile a thoroughly researched opinion piece on the stock's cheapness.
4. Using your reputation as a stock picker in a gambling mad city, watch said stock appreciate 35% the day after you release the report.
5. Repeat once a year.

In fact David Webb concisely summarises the mania and opportunities in the current market, including an astute observation of the level of the yuan:

In the last year, and particularly in the last few months, investors have, in our view, been indiscriminately exuberant over IPOs, commodities, energy and mainland consumer plays, and have lost sight of governance risk and fundamental valuation. A lot of hot money has also been chasing a narrow selection of large-caps, resulting in over-stretched valuations. Funds have been awash with cash and forced to invest it, and the retail public has begun to believe that all IPOs are guaranteed to make money just because some tycoon is buying it.

In Hong Kong, inbound liquidity to the mainland has kept mortgage rates artificially low and fuelled the property bubble. After a change in international accounting standards, companies' reported earnings now include property revaluation gains, but these represent the increase in the net present value of all the future years of income attributable to such assets, so they should be excluded when calculating the core P/E of the market, otherwise you are looking at a multiple on a multiple. Complacent analysts have been quoted as saying that the market's P/E is still "reasonable" or "attractive" at 14 or 15 despite recent record high prices. However, if you strip out property revaluations and other non-recurring items such as profits from sales of businesses, then the core P/E is now about 20, and it has spent very little time up there in the last 30 years. We haven't seen this much irrationality since the 1999-00 tech bubble, and you know what happened next. So look for a big sell-off of blue chips in the coming 12 months.

Meanwhile, if you do your homework, there are lot of cheap value stocks to choose from, particularly in the manufacturing sector, which is emerging from a difficult 2 years in which margins were squeezed by rising raw material prices. These have now stabilised or in some cases have begun to fall, allowing recovery of margins as the higher costs are passed down the supply chain. Meanwhile, the electricity shortages you read so much about in 2004-5 have been much reduced this year, as China brings new capacity on stream. You will also have read about the 3% appreciation in the RMB - but that is partly because the standard quotation of the currency is against the US dollar. In fact, the RMB has actually depreciated around 8% against the Euro in the last year, making exports to Europe more attractive and accelerating the outsourcing of manufacturing to China. This has gone some way to mitigating the rising cost of labour in China, and factories are also meeting the challenge by moving inland as the transport infrastructure improves, and by increasing automation where possible.

The end result? There's value to be had in the stock market, and it's not in those IPOs.

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