The Hang Seng Index declined by 488-point, or 2.1%, to 22711 on Mo nday with no apparent good reason. In fact, the whole Asia markets were on the plunge and definitely the rebound in U.S. dollar was putting pressure on equity as well as commodities. Yet volume was light at HK $64.5bn signifying investors were mostly watching on the sideline. Near term, the rebound in the U.S. dollar may continue, but should not be much from current level, and long-term the weakness is expected to return given the widening interest rate spread with other currencies.

Another factor contributed to today’s fall was probably due to derivative trading, I understand that some derivative issuers made some decent profits from the decline. May and June are traditionally the quiet months in a year and I expect a range trade of 22,500 to 24,000.

Instead of writing what I think will happen tomorrow or next week, I will dedicate my effort on a longer horizon, say 6-12 months. Stock market is a funny place, short-term it is driven by human psychology and long-term by economic fundamentals. I have to confess I rarely get the short-term movement right, comforting to know that few people do either, those who have this rare quality are already billionaires.

The HSI has fallen by a 1.4% YTD underperforming many developed markets. The reason is simple, investors fear austerity measures in China will continue, this is old news. The real question to ask is what can we expect in the 2H? I expect China ’s CPI to remain high in the next two months, ie. above 5%, before peaking in July.

The focus should be on May economic data recently released, including PMI manufacturing, industrial production, retail sales, money supply, they represent growth. Many of these data are lower on month-on-month basis and below expectation as well. If the trend persists into June and July, this seems to suggest China ’s GDP growth is slowing, this has two implications: (i) the austerity measures are beginning to show their effects in the real economy, (ii) inflation will start softening when economic growth slows. The PMI manufacturing figure due to release in early June should further reaffirm this view point.

Once that happens, it is not hard to imagine Chinese authority will start loosening the tightening measures. I think market will take this positively, given the low PE most stocks are now at, a strong rally is possible sometime in the 2H. Judging from the market performance in the past few years, the rally will be swift and strong but short-lived, perhaps lasting for 2 months breaking the previous high of 25,000. It is not exactly a fundamental buy but certainly a trading opportunity.

The commentary below was written for Equities by Benny Wong, the head stock ananlyst at a Chinese-owned company in Hong Kong. Benny is more of a long-view person than a day-to-day trader. He has been working in stocks in Hong Kong since before the Asian Financial Crisis in 1997, so he knows the ups and downs of the market.