Want an example of how quickly markets can turn? Look no further than Hong Kong. The benchmark Hang Seng equity index last week delivered its best performance in two months to reach its highest level in more than a year. That was followed on Monday by its steepest fall in seven months, as markets across the region sold off on fears over a possible rate rise from the Federal Reserve.

Neither the Hang Seng, representing Hong Kong and mainland Chinese blue-chips, nor its sister China Enterprises Index, made up of just mainland groups, recovered on Tuesday or Wednesday — unlike many regional rivals. That left investors asking whether the pair’s stellar run, which began back in February, was over.

Despite the slide at the start of the week, the two indices rank second and fourth best-performing worldwide over the past three months. That is no mean feat given the widespread concern among international investors over the scale of China’s ongoing economic slowdown.

The outlook for the markets depends on which drivers analysts are focusing on. As well as enjoying a lift from rising inflows globally into equities and emerging market funds in particular, Hong Kong has had its own unique kicker by way of cash from mainland China coming through its trading link with Shanghai — soon to be extended to Shenzhen.

“It’s not a fundamental story at the moment, it’s a flow and liquidity story,” said Jack Siu, investment strategist at Credit Suisse. The bank remains neutral on the Hang Seng, with a target of 23,000 points over the next three to six months. The index peaked at 24,114 on Friday.

Overall, analysts expect Hong Kong to receive less support from the wider push into equities that fuelled the summer rally. Chinese stocks, representing just over a quarter of the widely followed MSCI benchmark emerging markets index, duly benefited from their heavy weighting.

However, investors’ allocation to emerging equities is at its most overweight in more than three years, according to a monthly fund manager survey from Bank of America Merrill Lynch published on Tuesday. Investors are a net 24 per cent overweight compared with 13 per cent last month.

Indeed, trading will remain choppy ahead of meetings of both the Federal Reserve and the Bank of Japan next week. Michael Hartnett, chief investment strategist at BofA, said the bank’s survey showed investors feared a bond market shock “with the most crowded negative interest trades and EM equities susceptible should the Fed and especially the BoJ fail to reduce bond volatility”.

So where does that leave Hong Kong bulls? Reliant on flows from mainland China, where there is more reason for optimism, according to analysts.

So-called “southbound” — shorthand for mainland Chinese buyers — buying via the Shanghai-Hong Kong Stock Connect has been rising, and reached HK$9.2bn on Friday, its highest since April 2015 when the Chinese market was surging to multiyear highs.

Chinese regulators last month dropped an overall quota that limited the amount mainland investors can buy of stocks in Hong Kong via the Connect system. It also announced the long-awaited equivalent trading link to the Shenzhen market, which is expected to launch in the next few months.

Late last week, regulators took the step of allowing mainland insurers to use the Stock Connect mechanism to trade Hong Kong shares. That decision could produce an extra Rmb300bn ($45bn) of investment into Hong Kong stocks over the next two to three years, according to Credit Suisse. That would equate to roughly $1.3bn of monthly inflows into H-shares — the shorthand for Chinese companies listed in Hong Kong — or 1.2 per cent of monthly turnover on the Hang Seng index and HSCEI.

“The catalyst for Hong Kong is the anticipation of that inflow into the market, and that will be supportive of Hong Kong-listed blue-chips and above-average-yielding stocks,” said Mr Siu.

Even before freeing up insurers, analysts had noted a broader pick-up in activity from institutional investors, with the average size of southbound trades rising, suggesting fund managers, not retail money.

“With onshore investors and [companies] diversifying assets globally, China’s outbound investments are poised to rise further, benefiting Hong Kong’s financial markets,” says Wendy Liu, head of China equity research at Nomura.

Another key for Hong Kong will be the direction of the renminbi. Its gradual weakening this year has also boosted mainland interest in offshore investments.

“It’s better for investors in China to do a bit of currency hedging, and there’s quite a bit of money coming out from China that has increased turnover and supported the Hang Seng,” said Louis Tse at VC Brokerages.

On some valuation measures at the start of 2016, Hong Kong stocks hit their cheapest level in nearly two decades. With those easy gains now gone, Hong Kong faces a tougher challenge to sustain a run that has made it one of the best performers in the world.

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