Hong Kong Is Losing Premium Over Shanghai’s Stock Market

By Bloomberg News  

Photographer: Lam Yik Fei/Bloomberg

Riot police disperse demonstrators during a protest near central government offices in... Read More

Hong Kong’s biggest political unrest since the 1960s is wiping out the valuation premium of the city’s stocks over their Shanghai counterparts.
The Hang Seng (HSI) Index’s retreat to a three-month low today has eliminated the gap between dual-listed shares after it reached 12 percent in July. The Hang Seng has now dropped 1.1 percent this quarter, versus a 15 percent surge for the Shanghai Composite Index (SHCOMP), the biggest performance difference since 2009.
While Hong Kong equities have been held back by clashes between pro-democracy protesters and riot police in the city’s central business district, speculation of Chinese government stimulus has propelled shares in Shanghai. The divergence signals a growing preference for mainland shares before the start of a trading link next month that allows a net 23.5 billion yuan ($3.8 billion) of daily cross-border purchases.
“With the situation unfolding in Hong Kong, it is
conceivable that overseas investors could short Hong Kong as a hedge for their long Shanghai positions after the connect program commences,” Hao Hong, a strategist at Bocom International Holdings Co. in Hong Kong, wrote in a report yesterday.
The Hang Seng index dropped 1.3 percent to 22,932.98, while the Shanghai Composite rose 0.3 percent to the highest level since February 2013. Tens of thousands of protesters filled streets in Hong Kong through the night to press for open elections and the resignation of Chief Executive Leung Chun-ying, as student leaders set an Oct. 1 deadline for their demands to be met.

ETF Flows

The Hang Seng China AH Premium Index, which measures the weighted average gap between the largest dual-listed shares, rose to 100.36, the highest level since policymakers unveiled the exchange link in April. A level of 100 means H-shares in Hong Kong trade at the same price as A-shares on the mainland.
Investors poured $3.6 billion into exchange-traded funds tracking Chinese equities this year, more than three times more than they added into Hong Kong ETFs, according to data compiled by Bloomberg.
An average of 16 billion shares traded hands on the Shanghai Composite each day since June 30, almost twice the previous quarter and the most on record, according to data compiled by Bloomberg. Volume on the Hang Seng Index slipped less than 1 percent to 1.46 billion shares per day.

Exchange Link

“The Chinese A share market is showing all the signs of finally moving into a bull market after being a relative underperformer,” said Nader Naeimi, head of dynamic asset allocation at Sydney-based AMP Capital Investors Ltd., which manages about $125 billion. “What we have seen now is just a flick. There’s a lot more potential.”
The Hong Kong-Shanghai link will give foreign investors unprecedented access to mainland shares, allowing 13 billion yuan of net buying per day.
China is counting on a successful bourse link to help liberalize its financial system and increase use of the yuan. Existing rules restrict overseas money managers to foreign currency-denominated B shares, while only those approved under the Qualified Foreign Institutional Investor program can invest in yuan-denominated A shares.
Chinese institutions and investors with at least 500,000 yuan in their securities accounts will be able to buy Hong Kong shares using yuan through mainland brokerages. A CLSA Ltd. survey last month showed 77 percent of mainland investors don’t plan to participate in the bourse link, turned off by rules on the minimum account size and the exclusion of small-cap stocks.

Investment Themes

“The A-share market has lots of small companies engaged in the service industry, creating bunches of thematic investment,” Wei Wei, an analyst at West China Securities Co. in Shanghai, said by phone. “Similar targets are hard to find in Hong Kong. That’s why the market here is more active and outperforming Hong Kong.”
Chinese investors opened about 217,000 new equity accounts in the week ended Sept. 19, the most in two years, according to government data.
The excitement about mainland shares contrasts with a 2007 plan to allow Chinese citizens to buy Hong Kong stocks, later abandoned, which helped drive the Hang Seng Index to a record.
Market conditions were different then, with a rally in global equities and strong Chinese growth, said Erwin Sanft, the head of China and Hong Kong equity research at Standard Chartered Plc.
About $1.4 trillion was wiped off the value of global shares this month through Sept. 26 as investors reassessed the likely pace of U.S. Federal Reserve rate increases amid data showing a strengthening U.S. economy. Hong Kong’s dollar is pegged to the greenback, meaning the borrowing costs in the city track those in the U.S.
In China, the central bank is injecting 500 billion yuan into the nation’s largest banks to address weaker growth.
“The tightening of financial conditions that has brought about strength in the U.S. dollar is having a negative impact on the Hong Kong share market, whereas the same impact is not evident in China,” Naeimi said. “I continue to expect China A-shares to outperform China H-shares over the next year or two.”