The JF Investor Confidence Index in Hong Kong, designed to measure the outlook of retail investors in the local market over the next six months, has stabilised following a sharp drop in the previous quarter.

The index, which is derived from the results of a quarterly JF Asset Management survey conducted by independent market research company Cimigo, recorded a score of 119, slightly higher than the 117 recorded in the first quarter of 2008, but still much lower than 130 in the fourth quarter of 2007. JF Asset Management considers an index level of 100 as neutral and anything above that is regarded as positive.

For the latest survey, Cimigo randomly interviewed 500 retail investors in Hong Kong aged 21 to 60, with liquid assets in excess of HK$100,000 ($12,800). The latest survey was conducted in June and is the eighth since the poll began in July 2006.

Hong Kong investors are cautiously optimistic at best, says Terry Pan, JF Asset ManagementÆs head of retail business. They are taking a ôrelatively robust market viewö despite the gloomy scenario in the local and regional stock markets but are not optimistic to the point that they would readily put their money into play, he says.

In INGÆs own Asia-Pacific investor sentiment survey released earlier, Hong Kong bucked the trend and stood out as the market where investors were surprisingly upbeat while sentiment in the region as a whole continued to deteriorate.

The JF investor confidence survey covers six areas: Hong Kong stock market performance, local economic environment, local investment environment, global economic environment, personal asset valuations, and amount of investments. Each of these index components registered an increase in the latest survey, with the exception of plans to increase investments.

The improvements in Hong Kong investorsÆ expectations are difficult to marry with reality, with the Hang Seng Index closing at 21,223.50 on July 17, down 24% year-to-date.

Emerson Yip, a portfolio manager with JF Asset ManagementÆs Greater China team, notes that no matter how stable or even bullish investor sentiment is among retail (and indeed even mass affluent investors surveyed by ING), the fact remains that the bulk of the money that has pulled out from the local stock market belongs to global fund houses that have reallocated their assets or institutional investors that needed to pull back for whatever reason.

Around 56% of the survey respondents consider themselves conservative investors and said they allocate around 85% of their investment portfolios in Hong Kong. Those that have overseas investments tend to have most of them in mainland China-related shares, emerging markets and Asia. Looking ahead, investors who are planning to increase their overseas investments are still very biased towards mainland shares.

The bias towards mainland shares shows that investors are still looking for ways to improve investment returns, hedge against inflation, and are willing to go for high-risk assets to achieve this.

One area where Hong Kong investors have become more realistic is on their year-end expectation for the benchmark Hang Seng Index level. Six months ago, 80% of the respondents expected the HSI to trade within 25,001 to 35,000 by year-end. This time around, they have tempered their expectation to 20,001 to 30,000.

The good news is Greater China markets are relatively less affected by the problems in the US û which is being driven by the unwinding of the credit bubble there û and the concerns weighing on other global economies, says Yip. JF Asset Management is overweight in China and neutral in Hong Kong and Taiwan.

ôDecoupling to me is a verb and it is ongoing,ö Yip says. ôGreater China is less tied to the US but still intertwined at some levels. Overall, China is more isolated from the downturn because domestic consumption is rising as a percentage of GDP.ö

The problems faced by Chinese exporters going out of business are a ôreal concernö, Yip says, but one that wonÆt derail the mainlandÆs stock market further.

ôThe companies going out of business are not listed,ö Yip says. ôThe bigger listed companies will be able to consolidate and have greater pricing power. If anything, it opens up more opportunities on the investment side in China, Hong Kong and Taiwan.ö

Yip is not too concerned over inflationary pressures, which he believes will be managed by Chinese authorities better than their counterparts in other countries. Chinese authorities will have to take decisive actions to navigate the price issues, and they are in a position to do so, he says.

Valuations of China shares are attractive, Yip says, but they are not at distressed levels. The MSCI China 12-month forward price/earnings ratio is around 12 times.

ôChinese shares are definitely cheaper than they were a year ago, but not distressed,ö he says. ôWhat we see is a lot of growth potential at a reasonable price.ö

In Hong Kong, there are short-term headwinds given the marketÆs exposure to financial services and trade. However, Yip notes that there are many stocks with attractive valuations that are ripe for the picking, provided that the global economy doesnÆt experience a meltdown any time soon.

Among the good things about the Hong Kong market is it has the most number of defensive stocks available in the region and it still has a solid consumption story, Yip says. The defensive plays include property landlords, domestically focused local banks, and utilities.

Taiwan, meanwhile, is the most linked to the global economy among the Greater China markets, given that around half of its stock market index is made up of technology shares. The decoupling element in Taiwan is its increasing technology sales to China and other markets in Asia.

While there are short-term concerns in Taiwan, over the medium- to long-term, the efforts of the Kuomintang (KMT) or Nationalist Party to foster relations with China is likely to prove to be beneficial to the market. The connection to China has been surfacing more frequently since the victory of the KMT in the March presidential elections in Taiwan. President Ma Ying-jeou has offered to reopen dialogue with China, which claims the island as its territory, while promising to maintain self-rule and a distinct international profile.