Economy, Talking Point

Piling in

What explains this month’s sudden rally in Hong Kong stocks?

Woman walks past a panel displaying the closing Hang Seng Index outside a bank in Hong Kong

Green for go: big single day gains began to move the Hong Kong market upward last week

Sell in May and go away? Or how about the ‘January Effect’? The unpredictability of the financial world has bred a series of indicators for the world’s stock markets. Some are more unlikely than others. The Super Bowl Predictor, for one, suggests that should a team from the American Football League (AFL) win the final match of the season, investors should start getting nervous. Generally, the Dow Jones then heads south: the Wall Street Journal reported in 2008 that this unscientific screening tool has made the right call for the subsequent year in 33 of 41 Super Bowls, or an 80% success rate.

Over in Hong Kong, a city where feng shui practices often serve as a guide to the choice of office decoration and daily routine, the wackiest indicator comes in the form of the Adam Cheng Effect (also known as the Crab Ting Effect).

In 1992 Ting Hai was a stock market speculator played by Adam Cheng in the television series The Greed of Man. During the month or so that the drama was on air, Hong Kong’s benchmark Hang Seng Index (HSI) slumped by more than a fifth. Thereafter, whenever Cheng appeared in a new drama, the HSI seemed to take a dramatic turn for the worse. As such the Adam Cheng Effect found its way into financial newspapers, analysts’ reports and even a few examples of academic research.

But Cheng is on the verge of breaking his stock market curse. A singing show hosted by the 68 year-old has been broadcast for more than a month locally. And defying all the predictions about a Crab Ting collapse, Hong Kong’s stocks have surged nearly 20% in the same period.

That means that the Adam Cheng Effect may be confined to history, especially as analysts scramble for new explanations for the startling bull run in the Hong Kong market.

How buoyant is sentiment?

The year-end rally in Shanghai and Shenzhen meant that the Hong Kong market started 2015 in a rosier mood. But the HSI spent most of the first quarter hovering within a 2,000-point range, never breaching a 25,000-point threshold.

Then in early April investors returned from a five-day holiday, during which trading in the A-share market in China had stayed bullish. And on April 8, the HSI spiked nearly 1,000 points to close at 26,236. “This is truly the resurrection of Hong Kong stocks,” a columnist wrote in Apple Daily, with an eye on the just-passed Easter break.

After that, the market turned euphoric. Over the following three sessions the key index added nearly 2,000 points to breach the 28,000 level. The winning streak extended to eight consecutive sessions, propelling the HSI to heights unseen in seven years.

The surge came with historically high turnover too. Trading volumes breached HK$200 billion ($25 billion) for six successive trading days. (To put this in perspective, average daily turnover on the London Stock Exchange last month was $9 billion.)

“Hong Kong stocks have been on the up and up… and then up some more,” said Barron’s, a financial magazine, while local newspapers reported the sort of feverish activity typical of a bull market (or an overbought one, in the view of some). Retail investors crowded into bank branches to check stock quotes. while the online trading platforms at local brokerages seized up because of the intense trading.

How big is the Hong Kong market?

As of Monday, the market capitalisation of Hong Kong stocks set a new record, passing the HK$30 trillion ($3.9 trillion) mark for the first time. The 19% climb of the benchmark index year-to-date has also made Hong Kong the best performer in the world, aside from ChiNext, China’s growth enterprise bourse in Shenzhen, which has raced ahead 75% so far this year.

The rally is reshaping many of the global league tables, the Financial Times has noted. China Construction Bank (CCB), having surged 20% in a month, is now worth $248 billion, overtaking JPMorgan in market value. CCB is now the 15th biggest stock on the FTSE All World Index. Chinese brokerages have all seen their values inflate handsomely too. Citic Securities now carries a market cap of $61 billion, edging closer to Goldman Sachs’ $85 billion. It trades at a hefty 44 times price-to-earnings multiple, however, while Goldman is available at 11 times 2014 earnings.

The boom is great news for Hong Kong Exchanges and Clearing (HKEx), the operator of the Hong Kong bourse, and the only proxy for investors who want to own a slice of a Chinese stock exchange (both the Shanghai and Shenzhen stock bourses aren’t listed). The share price of HKEx has gained 70% so far this year, surging nearly 60% in April alone. On Monday it briefly surpassed the HK$300 per share mark (it went public in 2000 at HK$3.88 apiece), taking its market value to $36 billion and reclaiming its position as the world’s most valuable exchange from the Chicago-based CME Group.

HKEx was worth HK$265 a share when the HSI hit a historical high of 32,000 in October 2007. Back then, trading volume was around HK$100 billion a day. “With daily turnover breaching HK$200 billion HKEx could theoretically double (from HK$265). The question is how long such frenetic trading can go on,” the Apple Daily noted.

What explains the buying frenzy?

After years of poor performance, confidence in Chinese companies, many of them dual-listed in Hong Kong, has been returning. The revival was felt first in Shanghai’s A-share market (for more: see our special Focus issue last month) but the feel-good factor is spilling across the border too. In the past, cross-border capital flow into Hong Kong stocks was zealously controlled. Such restrictions are now being eased, primarily through the introduction of the Shanghai-Hong Kong Stock Connect. Debuted in November last year, the programme allows investors in Shanghai and Hong Kong to invest in each other’s markets (the new quota allows mainland punters to invest Rmb10.5 billion daily in Hong Kong stocks, see WiC252).

Initially, it was hoped that more experienced investors in Hong Kong (who tend to hold their stocks for longer) would help to stabilise the mainland market, which has often been driven by mom-and-pop speculators. But it seems the reverse is happening. “The prospect of fresh money from mainland investors through the same trading channel is pumping up buying in the Hong Kong market and making it more jumpy,” the Wall Street Journal reflects.

The Stock Connect scheme got off to a slow start and less than half of the ‘Southbound’ quota (money from China) was being used before the buying binge started in Hong Kong in April.

But changes in policy from mainland regulators seem to have opened the spigots, with much more cash starting to flood into the territory from Shanghai.

On March 27 the China Securities Regulatory Commission (CSRC) posted a seemingly unimportant statement on its website. Looking like a routine clarification, it confirmed that Chinese mutual funds were allowed to invest in Hong Kong shares via the Stock Connect scheme. The impact of the news took a few days to sink in around the Easter weekend, when traders were on holiday in Hong Kong. Mutual funds are one of the least regulated asset management categories in China and there are relatively low entry barriers for local brokerages to set up new ones. They also provide a huge new source of potential capital. BOC International, Bank of China’s investment banking arm, has suggested that Rmb100 billion ($16.15 billion) of mutual fund money could be raised in April alone for investment in Hong Kong stocks.

On April 8, the daily Southbound quota of Stock Connect was used up for the first time. “Stock Connect was one of the catalysts for today’s record high securities market turnover,” HKEx chairman Chow Chung-kong, told reporters after trading volumes hit HK$291 billion. “The programme has given us another source of market liquidity that was enhanced by the mainland authorities’ recent clarification of policies regarding institutional investor participation in Stock Connect.”

Any alternative explanations?

In a bull market like this, brokerages do their best to come up with different investment theses to keep investors at fever pitch.

Policy initiatives from the central government in Beijing, the Financial Times suggested, provide some of the most popular explanations for the boom. The “One Road, One Belt” concept – Xi Jinping’s ambitious plan to stoke foreign demand for Chinese heavy industry firms by financing infrastructure spending around Asia – is one of the most mentioned reasons. Another popular theme is the reform of some of the larger state firms. Shares of train makers CSR Corp and CNR Corp both climbed more than 40% on April 8, on news that their planned merger had been given the regulatory green light. The Xinhua-run China Securities Journal says more drastic reform and restructuring in the state sector could follow, fostering further M&A among some of China’s heavyweight companies.

Others have turned to conspiracy theories as they search for explanations for the sudden exuberance. For instance, The Oriental Daily, the city’s biggest newspaper group, has wondered whether the rally is being driven by “political buying”. It believes that foreign speculators have accumulated huge short positions in Hong Kong stocks, hoping to exploit uncertainties about the territory’s electoral reforms (see WiC244), as well as its longer-term future as a window on China.

The implication is that Beijing is now meting out a lesson. “The central government thinks it’s the right time to squeeze (the short positions of) these speculators, and to prevent Hong Kong from becoming the foreign crocodiles’ dim sum,” the newspaper proposes.

Even if the Beijing-versus-the-’foreing barbarians’ theory sounds far-fetched, many investors do seem to believe that bolstering of market sentiment – both in the mainland and in Hong Kong – is high on the central government’s policy agency.

Adding credence to this interventionist school are articles like China Securities Journal’s “Go! Buy Hong Kong stocks!” (Although despite the catchy headline, it actually advises investors to be cautious with their capital.)

Another expansion of the Stock Connect scheme would add weight to the speculation that Beijing is ready to be bolder in boosting the market. Given the recent surges in trading volumes, Hong Kong officials have said an adjustment to the Southbound quota should be considered. Moreover, they anticipate that a similar arrangement between Hong Kong and Shenzhen – China’s second bourse – will be put in place this year.

Steven Sun, HSBC’s head of China equity strategy, also expects a series of policy moves to make it easier for mainland retail investors to switch their attention to Hong Kong. These include the introducing of margin trading for Southbound investors, and the cross-listing and sales of mutual fund products.

How about the fundamentals?

Here, it’s harder to justify all the excitement. The economic data coming out of China continues to look weak. This week March exports showed a jarring 15% decline from a year earlier, while imports also dropped 12%. China’s GDP in the first quarter grew at its slowest pace in six years, at 7%. “Sceptics could only shake their heads”, the Financial Times noted in its Lex Column, as Chinese stocks “shrugged and continued their ascent”.

Even here, the case can be made for another hike in share prices. Weak trade and investment data (and low inflation) signals that more monetary easing could be ahead – which is good news for many stocks in Shanghai and Hong Kong. On the other hand, the debate is growing about whether Chinese shares are already in bubble territory.

Naturally, market boosters deny it. Banking shares, for instance, carry the heaviest weighting in the Hang Seng Index in Hong Kong. And despite the recent run-up in values, the likes of ICBC and CCB are still trading on single-digit price-to-earnings multiples.

Pessimists counter that this is due to doubts about the banks’ loans and that the situation could soon turn ugly in the event of an implosion in credit quality.

Looking at the bigger picture, the Hong Kong Economic Journal notes that quantitative easing (the era of ‘cheap money’) has been a global phenomenon, and that most major equity markets including the US and Japan have been trading at historically high levels. If this holds, the paper opines, there could still be upside in Hong Kong stocks. The index is still trading 14% below its all-time high, or the 32,000-level registered in October 2007.

As demand grows from investors from the mainland, it is surely important that many Hong Kong stocks are seen as relatively cheap too, compared to their Shanghai or Shenzhen-listed counterparts, which have raced up in value over much of the last year. There are 88 companies dual-listed in Hong Kong (with H-shares) and in mainland China (in-A shares). Less than five have H-shares pricier than their A-shares. An example: state miner Yanzhou Coal, which has been trading at Rmb15.6 in Shanghai but could be bought for HK$8.4 in Hong Kong on Wednesday this week. This implies a hefty 133% premium for Yanzhou’s shares in China, once the currency is factored in. The valuation gap makes some H-shares look cheap, the Hong Kong Economic Journal says, and it expects more price convergence between the two markets.

Quite how much this could add to Hong Kong’s boom remains to be seen. But investors might want to grab the opportunity while they still can. Television channel TVB will next week rebroadcast The Greed of Man, the series that first triggered the ruinous Adam Cheng Effect. After that, it may be time for a little profit-taking…

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