The Year of the Tiger is traditionally a turbulent one. Tigers are powerful and brave but also unpredictable. So what, if anything, does this mean for the financial markets in China and Hong Kong?

Innovative Investor hears from Kenny Lau, head of small-cap sector, non-Japan Asia and Vincent Chan, head of China research at Credit Suisse on their predictions for the Year of the Tiger.

Innovative Investor: Some investors put great store by the Chinese Zodiac, so what are your predictions based on your research?

Kenny Lau: The year of the Tiger won't be easy for anyone. We will all need to work much harder on absolute returns. We still prefer small caps with low valuations, and if you can generate positive returns which outperform the market you will have done well.

Innovative Investor: Some investors believe that whatever the market does on the first day of the New Year will be the way the market moves over the full year. This year the Hang Seng fell on its first day of trading from 21872.5 to 21823.28, so does this mean the market will be slightly below the level at the end of 2009 on 31 December 2010?

Kenny Lau: Recent history says this is 100% accurate. Last year we had a 4.6% rise on the first trading day and then a 52% rise for the full year. This year, on 4 January the Hang Seng was down, so if we take this as a prediction for the year the market will be below 21,822 by the end of this year.

However, Credit Suisse is predicting GDP growth in Hong Kong of 4.6%, and 9.6% for China. For the Hang Seng Index target in 2010 we are looking for 24,600, and for Shanghai A-Share we are looking for 3,300.

Innovative Investor: Is there a bubble in China's property market?

Vincent Chan: There are some serious bubble issues in some parts of China, which are related to the property sector.

China has a very big property bubble in high end market, where people are just buying properties and not doing anything with them but holding them for long term capital gains. But unlike just about every market in the world, this bubble is difficult to burst because Chinese buyers generally speaking have a very strong balance sheet and they are not leveraged up.

Our Chinese consumer survey from the end of 2009 found that since 2004 (when we first began conducting the survey) household income has increased between 50% and 250%. Most of the income growth has been among the wealthiest consumers. It is becoming more and more uneven. The survey also found that saving levels have fallen and that most of what was being put into savings is now being put into property.

Innovative Investor: What about the size of government debt in China, are you concerned?

Vincent Chan: This is now a big issue in China. Basically local government debt is increasing. Our forecast says that in 2007 local government debt was around 4 trillion RMB, and we expect this to have increased to 12 trillion RMB by the end of 2010. The reason it is growing so quickly is the same reason as to why the Chinese economy has picked up so quickly last year - infrastructure spending. Most of these projects were local government projects financed by the banks. Central government is now concerned, and in September last year put in tighter rules regarding infrastructure budgets.

But even with all the new spending it was only around 12 trillion RMB, which was around 33% of GDP. And in absolute terms is not very big; this is a manageable number. Therefore it is not the beginning of a financial crisis in China, but it does mean a slowdown in the rate of infrastructure spending in the next few years in order to prevent it from getting bigger.

Innovative Investor: What impact will the varying state of the Western economies have on China and Hong Kong?

Vincent Chan: Underlying liquidity in the market is still strong, bit looking at what happened in Europe, liquidity will become an increasing concern. There has been a general rise in risk aversion in the markets and this is not good for emerging markets.
And, generally speaking, a strong US dollar is bad for emerging markets, so I think with what is happening in Europe, the US dollar will rise and this will not be good for emerging markets.