High time for retail sales to make cyclical bounce in 2H14

This follows 2Q14's plunge.

Retail sales in Hong Kong are due for a cyclical bounce in 2H14 after the plunge in 2Q14. However, there is still much skepticism on the medium-to-long term outlook of Hong Kong's retail sector.

According to a research report from UBS, capacity constraint in the tourism and hospitality sectors, plus the souring of local sentiment towards the Mainland tourists, suggests that policy will be bias towards restraining the number of Chinese arrivals.

It is now widely recognized that the retail sector has well past the peak of the structural boost from Chinese tourist spending.

However, over the next couple of quarter retail sales should resume growth, both in sequential and year-on-year terms, driven in part by China's cyclical improvement.

Here’s more from UBS:

Retail sales value contracted 7.0%y/y in 2Q14, the third sharpest quarterly decline on record.

Granted, the high base last year, reflecting rush demand for gold in 2Q13, was one reason for the depressed year-on-year comparison.

But high base aside, there had also been a real and significant deterioration in sequential sales momentum, with sales contracting almost 6% quarter-on-quarter seasonally adjusted (or 21% annualized) in 2Q14.

What could have driven the plunge? We don't think it was due to a slowdown in arrivals. Yes, arrivals did slow in 2Q14 but the deceleration to 10%y/y from 15%y/y in 2Q14 was moderate and therefore did not represent the biggest drag.

What's left in the equation are domestic spending and per-capita tourist spending (Chinese tourists in particular). And we suspect continued poor domestic spending and a very sizable decline in per-capita tourist spending were to be blamed.

Still, the fall in visitor spending was much sharper-than-expected and it also appeared excessive relative to fundamentals. So technically, sales could be due for a bounce if pent up demand is released.

If history is a guide, sales typically resume sequential growth after a quarter of very steep fall. There are also fundamental supports in the near term.

In particular, easier Chinese credit, slightly stronger Chinese growth, plus recent stabilization in domestic asset prices should provide some cyclical boosts to the retail sector over the next two quarters.