It’s a reminder of how froth can overwhelm basic value investing principles in a booming market. Companies with equity listings in both cities are about 13 percent less expensive in Hong Kong than on the mainland, the widest gap since June 2012, according to the Hang Seng China AH Premium Index.
As recently as last month, the relationship was reversed, with Hong Kong shares trading at higher prices on average than their peers some 760 miles to the north. The valuation gap turned in Shanghai’s favor as China opened up its market to more foreigners last month by linking up with the Hong Kong exchange, and the nation’s central bank unexpectedly cut interest rates to combat the
weakest economic expansion since 1990.
Mainland shares “are dominated by retail investors, who don’t pay too much attention to fundamentals such as valuations,” Lu Wenjie, a Shanghai-based strategist at UBS Group AG, said by phone yesterday. “Playing in a market with more inflow can make you money, so it’s natural that A shares are outperforming.”
A man washes a window near a stock board outside of a Wing Hang Bank Ltd. branch in Hong Kong, China.
Margin Trading
The Shanghai Composite Index’s 21 percent rally in the past month has reduced the appeal of shifting money into Hong Kong through the city’s three-week-old exchange link, defying predictions that the program would erase price gaps between dual-listed shares. While trading volumes in Shanghai climbed to a record today, mainland investors have left more than 90 percent of their quota of Hong Kong stock orders through the link unused.Smaller volumes in Hong Kong and the inability to trade with margin debt are a deterrent for mainland investors, according to Lu, while they also need to have a minimum 500,000 yuan ($81,236) in their stock accounts to use the program.
The Shanghai Composite jumped 17 percent since the link began on Nov. 17 through yesterday to the highest levels since 2011. The Hang Seng Index (HSI) of Hong Kong shares fell 1.1 percent, while the Hang Seng China Enterprises Index of mainland companies listed in the city was up 6.7 percent.
PetroChina Rally
PetroChina surged 18 percent in Shanghai in that time, compared with a 2.1 percent loss in Hong Kong. China Petroleum & Chemical Corp.’s yuan-denominated A shares advanced 19 percent, including a record 11-day winning streak, while its H shares in Hong Kong rose 2.5 percent.The Shanghai gauge added 1.3 percent to 2,937.65 today, while the Hang Seng China AH Premium index increased 1.5 percent, signaling a bigger premium on mainland shares. Chinese investors used up about 1.4 billion yuan of their daily quota through the Hong Kong exchange link, the most since Nov. 17.
China’s $4.7 trillion domestic stock market is surging after the central bank cut interest rates for the first time since 2012 last month and analysts predicted the monetary authority will take further steps to support growth in the world’s second-largest economy.
“The premium could still widen near-term because of the strength of the bull run in A shares,” said Jonathan Garner, the Hong Kong-based head of Asia and emerging-market strategy at Morgan Stanley. The link “is a step toward the eventual creation of a ‘One China’ equity market,” though volumes so far have been “relatively low,” he said.
Economic Outlook
While Chinese investors are allowed to buy an aggregate 250 billion yuan of shares in Hong Kong through the exchange link, they’re limited to using margin debt for about 900 stocks on the mainland. Traders purchased 99.7 billion yuan of shares using such loans on the Shanghai exchange Dec. 3, taking the outstanding value of equity purchases using borrowed money to a record 552.1 billion yuan, according to data from the bourse.International investors who dominate trading in Hong Kong are less optimistic than locals on the outlook for China’s economy, according to Lu at UBS. China is headed for its slowest full-year economic expansion since 1990 amid a property slump, weakening industrial output and a jump in bad debt. Non-performing loans surged 10 percent last quarter, according to the central bank.
Air China
“China’s stock rally in the last two weeks can’t be explained by any economic fundamentals,” said Ken Peng, a strategist at Citigroup Inc.’s private bank in Hong Kong. “If the central bank shifted course in easing, China’s stock market rally would fizzle away very quickly.”It may be time to buy discounted shares in Hong Kong to benefit from a rally as they catch up with counterparts in Shanghai, according to Aaron Boesky, who oversees about $100 million as the chief executive officer of Marco Polo Pure Asset Management in Hong Kong and has been investing in China for the past 11 years.
China Petroleum, known as Sinopec, traded at a 17 percent discount in Hong Kong compared with Shanghai yesterday. Air China Ltd., the nation’s biggest airline by market value, is 26 percent cheaper in Hong Kong, while Jiangxi Copper Co. (358), China’s largest producer of the metal, costs 39 percent less.
“You are going to continue to see a run-up in A shares,” said Boesky. “What it will probably do is drag up the H shares.”
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