Hong KongÆs benchmark Hang Seng Index (HSI) has fallen sharply over the past months and Morgan Stanley considers that a healthy correction.

ôWe downgraded our Hang Seng Index outlook three months ago because the excessive valuations were not supported by the fundamentals, but the HSI has now fallen to slightly below our current fair value. After this healthy correction, the HSI could reach 30,000 by end-2008, up 22% from current levels,ö Rob Hart, Hong Kong strategist at Morgan Stanley Asia, and his team write in a recent report.

Morgan Stanley is stopping short of becoming more aggressive on the Hong Kong market because the near-term uncertainty is high, and it is waiting for better transparency and a lower entry level.

Looking ahead, Morgan Stanley believes a US recession wonÆt be a problem for Hong Kong if the local economy remains resilient, which it believes it will. Private consumption should remain strong in Hong Kong given the positive income and wealth effects from a tight labour market and rising property prices.

The HSI jumped 33%-35% during the recessions in 1980 and 1990 and fell 11%-39% during the recessions of 1982 and 2001, according to Morgan Stanley data.

ôThe difference between the performances is dictated by the economy, which obviously correlates to retail sales and real mortgage rates,ö the report says.

While it doesnÆt see a US recession as an obstacle to Hong Kong, Morgan Stanley nevertheless favours stocks that have as little to do as possible with the US economy.

ôWe advise buying stocks that are attractively valued and benefit from falling US rates, and where the US recession will have limited impact. We have been bullish on the Hong Kong developers and banks for 18 months, and after the recent correction, there is some upside to these stocks again,ö the report says.

Macau gaming and property stocks also both appeal to Morgan Stanley, as do the two quality retail names, Li & Fung and Esprit. Even some of the China names are looking attractive, including the bank and oil stocks.

Meanwhile, a fall in China property prices would lead to a slowdown in the China economy and may have negative contagion to the Hong Kong economy, possibly at the same time as the US begins to raise rates, Morgan Stanley warns. However, ôthis is probably a 2009 story, but will require attention sooner, though not yetö.