Hang Seng Index rose by 17.4% since January 2015

Will this push the economy up?

It has been asked if whether the recent equity rally will give the Hong Kong economy a much-needed boost.

According to a research note from Hang Seng Bank, in its analysis, the impact is not as significant as some observers might think, given the distribution of the associated wealth gains.

In short, wealthier households that hold more stocks tend to have a lower marginal propensity to consume.

Here's more from Hang Seng Bank:

Driven by a pickup in flows from mainland China by investors seeking more attractive valuations, the Hong Kong equity market rallied across the board and hit a seven-year high in April. Even with the recent correction, the Hang Seng Index has risen by 17.4% since the beginning of 2015.

The market capitalisation of the Hong Kong market at the end of April have reached HKD30 trillion, an increase of 20% since the end of 2014. Taken at face value, such a massive increase in wealth, which amounts to about 226% of GDP, should generate a substantial wealth effect that will boost consumer spending.

Our estimates, however, indicate that the wealth effect is not as big as might be assumed. It is worth recalling that exposure to the domestic stock market among Hong Kong households is much smaller than that suggested by headline stock market capitalisation.

In 2013/14, local retail investors only accounted for 24.5% of Hong Kong’s total market turnover value. What is also often overlooked is that the distribution of wealth gains generates substantial moderating effects. High-income households holding more stocks tend to have higher savings rates and lower marginal propensities to consume. Finally, income expectations matter.

Wealth is not a proximate cause of higher consumption, but rather reflects changing expectations that drive consumer spending. It is easy to see how the bull market after the global financial crisis coincided with a strong run for consumer spending.

That has not been the case in this cycle, however. Renewed capital inflows this time around have little to do with improved labour income prospects and much more to do with the valuation gap between Hong Kong and Shanghailisted companies.

Few studies have specifically estimated the financial wealth effect in Hong Kong. Among the large body of analyses based on US samples, researchers conclude that consumers spend between 2 and 3 per cent of their extra financial wealth. Most studies also find that the effect of wealth gains on consumption spreads over time. Drawing lessons from these studies, we smoothed the wealth effect by assuming that HKD1 of net financial wealth has a HKD0.01 impact in the current quarter, HKD0.005 in the next quarter, and HKD0.0025 in the following two quarters.

The exhibit suggests two conclusions. First, equity market strength could potentially raise Hong Kong’s private consumption and GDP growth this year by 1.3 percentage points and 0.8 percentage points, respectively, assuming the current valuation level can be sustained.

Second, the wealth effect of the recent stock market rally is expected to gain traction and will act as an important cushion for external shocks in the second half. In fact, our baseline forecast for an acceleration in consumption growth in the quarters ahead requires no pickup in the underlying trend. We remain sanguine over the consumption momentum of local residents.