Wednesday, October 1, 2014

Political Protests in Hong Kong: The Market Overreacts

Geopolitical risk is essentially uncertainty to the market. Given the nature of human fear, the psyche can add a “multiplier effect” to an objective calculation of uncertainty. Just as we are naturally so close to human nature that its most ubiquitous tendencies eclipse our notice, so too do we tend to assume that the market’s assessment of a political risk is accurate, given the efficiency and effectiveness of the stock market. The market’s initial reaction to the political protests in Hong Kong in September 2014 may demonstrate that the market’s participants even routinely overstate both the probability and severity of the downside of a mass political event.

Under China’s “one country, two systems” accommodation of Hong Kong’s free market and democratic past, the semi-autonomous nature of the former British colony was presumably at risk as young adults protested Beijing’s decision to have a panel select three candidates to run for chief executive of Hong Kong in 2017. When the British returned the colony to China in 1997, the Chinese Government had promised that the post would again be elected democratically. To the protesters in 2014, the empty promise was a betrayal that could be read as a baleful sign of what life would be like under the rule of Beijing.

As though a knee-jerk reaction to the sight of large crowds taking to the streets in Hong Kong, stocks of companies having significant operations in or through Hong Kong lost value on the New York Stock Exchange on September 29, 2014. Iao Kun, for example, lost 6 percent, while Exceed lost 3.6%, Bonso Electronics lost 3.1%, and Global-Tech Adv. Lost 3 percent.[1] “Markets are jittery because anything that threatens Hong Kong’s status as a one country, two systems place could (affect) the world economy,” said Rod Smyth, chief investment strategist at Riverfront Investment Group.[2] I’m not convinced by this reasoning.

Firstly, Chinese communism had already come to embrace the government-influenced “free” market, so it does not follow that squashing the political protest would imperil firms in Hong Kong; it is not as if the private property would be grabbed by the government. Secondly, Beijing had a strong economic incentive at the time not to compromise Hong Kong as an economic engine. Ignoring this point, investors in the New York stock market overlooked the ability of Chinese officials to put down the protest without necessarily touching businesses in Hong Kong. That Beijing had the strange (to Western ears) fear that Hong Kong’s political freedoms would “infect” the rest of China does not translate into a fear that Hong Kong’s wealth might also “infect” other cities—as if too thriving cities would be a bad thing.[3]

Smyth claims the big “risk is this thing [i.e., the protest] escalates and China starts to get mad at protesters and comes in with a heavy hand and changes other things.”[4] The vagueness in this residual is itself an invitation for investors and stock analysts to extrapolate imprudently—which is to say, without much of an innate sense of the threshold beyond which lies blind fear tripping over itself ad infinitum. What things exactly? This question invites an orgy of uncertainty. Even if Hong Kong were to lose its semiautonomous status in China, it does not follow that Beijing would turn the city upside down. Rather, the objectionable political protests would likely result in modest political-only changes—keeping in mind China’s stake in Hong Kong’s role in the global economy. After all, even as semi-autonomous, Hong Kong cannot elect its chief executive freely. How much autonomy did Hong Kong have in 2014 that it would lose? The market’s initial reaction is not based on business fundamentals, but, rather, on irrational uncertainty.

[1] Adam Shell and Kim Hjelmgaard, “Hong Kong Protests Buffet Markets,” USA Today, September 30, 2014.
[2] Ibid.
[3] Calum MacLeod, “’Umbrella Revolution’ Opens Wide,” USA Today, September 30, 2014.
[4] Shell and Hjelmgaard, “Hong Kong Protests.”