Hang Seng Index finally breaks out, advances on 2007's record high

Bubble warnings have emerged.

It has been noted that after five years of grinding indecision, Hong Kong’s Hang Seng Index has finally broken-out and is advancing on the record high from 2007.

According to a research note from CCB International, further, although the market has only just begun to exhibit confidence, warnings of a bubble have already emerged.

Such warnings are premature. After five years of diffident price action, one’s only concern is to participate in this rally, which in CCB International's view can run a lot further.

Here's more from CCB International:

Earnings drive the long-term trend in equity markets, but they do not drive equity markets over shorter periods. Indeed, even if we could forecast year-off earnings perfectly, we could explain less than 10% of the annual move in the Hang Seng Index over the past 20 years.

Over shorter periods, changes in the demand for and supply of equities as an asset class will dominate equity market performance. These influences are best viewed as factors which can temporarily drive a market away from the long-term trend.

The chart at top right plots the Hang Seng Index against our measure of the long-term trend, which is a function of the long-term trend in earnings.

Over the long haul, the market always returns to the long-term trend, but it can deviate from the trend for protracted periods. The chart at lower right shows the percentage deviation of the HSI from the long-term trend since 1974.

The chart assumes an HSI reading of 28,000 at the end of this month. Such a reading would put the index 23% below the long-term trend – roughly where the market was at end-October 2008 and at roughly half the index reading we would expect to see at the peak of a bubble.

To be sure, the market fundamentals are poor and China’s economy might not reverse its slowing course. But the market’s current position in relation to the long-term trend suggests the market can run further - a lot further before we need to entertain concerns over a bubble.