Why the Hong Kong stock market rally's got legs

Hong Kong stocks as measured by the Hang Seng are up 10.88% so far this month and 16.98% in 2015. The H-share index, where you can buy mainland shares listed in Hong Kong, is up even more.

Much of this gain has been in the past week as mainland Chinese investors, long focused on Shanghai stocks, have started funnelling money through the Shanghai-Hong Kong connection.

This move from the mainland to Hong Kong seems “extremely prudent”, according to Chris Weston, Chief Market Strategist at IG who said it was driven by “the huge valuation discrepancies between A and H-share listed corporations”.

Weston highlighted just how far the exuberance has taken Shanghai stocks compared to their Hong Kong counterparts. “In Hong Kong only, 5% of stocks have a current P/E (price-to-earnings) ratio of 50x or above. To put that in perspective, 44% of companies on the Shanghai Composite are trading on a multiple of 50x and 22% on over 100x!”


But Hong Kong shares also stand out on a global P/E basis Weston says. Hong Kong-listed mainland stocks trade at “10 times consensus forward earnings”. Compare that to the Shanghao Shenzhen CSI 300 at “16.17x, S&P 500 at 17.74x and Nikkei at 19x.”

Source: Bloomberg

So Hong Kong looks cheap against both the globe and Shanghai.

But Weston highlights there is a clear arbitrage opportunity waiting to be closed:

As things stand, there are only four stocks on the H shares market trading at a valuation premium to their A-share listing (Anhui Expressway Co, China Merchant Bank, Vanke and ICBC). All other 89 stocks are at a discount. So traders looking at arbitrage opportunities will still see these in abundance.

CLSA Hong Kong analyst Francis Cheung agrees, saying the recent high of a 35% premium between shares listed in Shanghai over those listed in Hong Kong is unsustainable. “The government will manage A-share rally by allowing more liquidity into Hong Kong and doing more IPOs,”s ays Cheung. “This is what happened in 2007.”

That biases the H-Share index higher yet which will help take the Hang Seng and overall Chinese stocks with it.

Add to that the fact that there has already been one Y11 billion fund created to specifically buy Hong Kong stocks under the stock connect system, with more rumoured to being established and the preconditions for a wall of money to flow down the pipe to Hong Kong for an extended period are set.

Weston says that the PBOC, the central bank, is likely to need to continue to ease monetary policy as the economy slows and as the rate of monetary circulation slows.

Hong Kong stocks are ripping higher but it seems they might have some way to go yet.

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