Hong Kong stocks are so unloved by investors this year that their valuation has sunk to the lowest in more than four years relative to their peers in mainland China. For some of the market’s most accurate stock forecasters, the tide may be about to reverse.
Companies listed in Asia’s third-largest market, commonly known as H shares, trailed their equivalent A shares on mainland China bourses by 43 per cent last week versus 27 per cent in March, according to the Hang Seng Stock Connect AH Premium Index. The discount is the deepest since February 2016 and double the historical average.
The last time this happened, the Hang Seng Index rallied by almost 40 per cent in the subsequent two years, while the Shanghai Composite Index slumped 5 per cent.
“H shares are better in terms of valuation,” said Hong Hao, managing director at Bocom International in Hong Kong, who correctly predicted China’s stock market crash that wiped out US$5 trillion in 2015. “A shares are clearly running into resistance.”
A rebalancing of the Hang Seng Index, for a start, could entice big institutional buying as some of the hottest technology stocks such as Alibaba Group Holding and Xiaomi attract managers of global index-linked funds.
Alibaba, the owner of this newspaper, Xiaomi, and Wuxi Biologics will become the index components from Monday, replacing Want Want, Sino Land and China Shenhua Energy. This will raise the weightage of technology firms in the index to about 10 per cent.
“This can serve as a catalyst” as the tweak attracts allocations from passive global investors, according to Wang Hanfeng, an analyst at China International Capital Corp.
To be sure, H shares have historically been more richly valued over their peers in Hong Kong since the Hang Seng Stock Connect AH Premium Index’s inception in 2006. The premium peaked at 108 per cent in January 2008, a few months before the global financial crisis.
The Hang Seng Index of 50 members has dropped 12 per cent this year, as its average price-earnings multiple slipped to 12.9 times, according to Bloomberg data. The Shanghai Composite has advanced 10 per cent in 2020, lifting its price-earnings multiple to 18 times.
That may be a reflection of the current phase of the economic cycle. Hong Kong’s gross domestic product has shrunk in four straight quarters through June, its worst recession on record, as the city is caught in the middle of the worsening US-China relations.
In China, easy money and stimulus efforts helped deliver a 3.2 per cent expansion in the second quarter after a historic slump at the start of the year. Authorities have effectively declared victory in the fight against the Covid-19 pandemic, as factories, domestic flights, vehicle sales and tourism recovered.
Shares of all 127 dual-listed Chinese companies were priced at a premium on mainland stock markets as of last week, according to data tracker Shanghai DZH.
Ping An Insurance (Group) had the smallest price-gap, while the biggest are concentrated on smaller companies such as auto part maker Zhejiang Shibao and Shanghai Fudan-Zhangjiang Bio-Pharmaceutical.
“There’s a big chance of price convergence in the long run because of such a wide premium,” said Ou Fafei, an analyst at GF Securities based in Guangzhou.
Gains in Chinese stocks on mainland bourses appear to be losing momentum, with the Shanghai Composite Index locked in a narrow range over the past two months since the gauge hit a two-year high in July.
HKEX wants to create another wave of mega IPOs in Hong Kong to stay ahead of Nasdaq in next market reforms
Uncertainty linked to the US-China ties is one of the major factors holding back Hong Kong stocks now, according to Chen Li, chief economist at Soochow Securities.
Still, more new-economy stocks are making their way to Hong Kong listings. About 45 US-listed Chinese technology companies could probably raise a total of US$55.7 billion in IPOs, he said. That’s equivalent to the entire amount raised in 2019.
“These new-economy hi-tech companies’ expected presence in Hong Kong market will bolster both liquidity and valuations,” Chen said. “We expect further significant upside room to run on consumer, information technology, pharmaceutical and telecom sectors.”
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