H-share index rises to eight-year peak as investors buy into China story, pumping funds into equities It has been one H of a year so far for Hong Kong-listed mainland stocks. Over the past eight weeks, huge amounts of cash have been piling into H shares in a manner not seen since before the Asian financial crisis as investors buy into the China story. Stocks from the financial, consumer and resources sectors have all shone, thanks to the persistently strengthening mainland economy. The H-share index has jumped 24.08 per cent since the start of the year, far outperforming the benchmark Hang Seng Index's 6.59 per cent gain. It reached an eight-year high of 6,717.19 points on Wednesday, beating all the predictions made at the end of last year by analysts polled by the South China Morning Post who said it would range between 5,500 and 6,500 this year. In the past 10 trading days, the index has gained 4.44 per cent as recent government policy news feeding through the market prompted funds to chase obvious beneficiaries. It has also been spurred by the index compiler HSI Services' announcement two weeks ago that H shares will be eligible for inclusion in the blue-chip index. Earlier this week, senior officials from the State Administration of Foreign Exchange sounded out the market about further easing of capital outflow restrictions this year. This, together with speculation of further yuan appreciation, gave the already eye-catching mainland financial plays an even brighter sheen with China Construction Bank Corp and China Life Insurance benefiting from double-digit percentage increases in two weeks. Referring to the impact of liberalising capital flows in and out of the mainland, research analysts Vincent Chan and Susan Chan of Credit Suisse said in a report that it was 'reasonable to expect that in the early stage, most of the investments from mainland investors will be concentrated in large-cap China stocks listed in Hong Kong, particularly those that they cannot buy in the A-share market'. Although the H-share index has undergone a correction in the past two days because of inevitable profit taking, investors are expected to remain bullish as it is China's economic prospects that are driving a long-term rally. 'At this level, H shares have more or less fully reflected the short-term share-price catalysts such as further yuan appreciation, the inclusion of H shares into the Hang Seng Index and the [qualified domestic institutional investor scheme]. It's normal to have a healthy correction,' said Eleanor Wan, a director and head of fund business at Allianz Global Investors. 'We are still positive on the H-share long-term outlook as robust economic growth in the mainland is still the key.' Baring Asset Management (Asia) Asian equities sales director Lilian Co said: 'While H shares have risen a lot, I think it is premature to say that the H-share index has reached its peak. 'In the past two years, investors have been cautious towards investing in mainland shares due to the government's macroeconomic austerity measures, but since the fourth quarter of last year people realised the worst of the impact has been reflected, particularly given the economic data released has been positive. 'Emerging markets like India, Brazil and South Korea rose a lot last year, while China lagged behind. The H-share market's [price-earnings ratio] of around 12 is lower than that of these other markets, so from the global perspective, H shares are still relatively cheap, although not from a historical perspective. 'I think investors need some time to get used to the higher valuation of H shares now that they have risen so much. While there will be short-term corrections, the long-term rising trend has not been damaged. 'This year is definitely a year of China ... whether it will be A, B or H shares' year ... I think H shares have a better chance than A and B shares.' Ms Co is bullish on China's retail, car, financial and property sectors, which she said would benefit from the country's consumption growth. Car stocks have more room for upside given their rally came later than the financial stocks. Bank of China International Research, which has a target of 6,000 for the H-share index this year, is considering raising that figure. Managing director Anthony Lok said as more mainland financial stocks were added to the H-share index, diluting the impact of heavyweight oil stocks, the index would track the mainland economic growth more directly and thus would see further upside. 'Financial stocks are the best plays to reflect economic growth and a more balanced mix in the index would help to reduce volatility, smoothening the index upside,' Mr Lok said. According to the Chinese Academy of Sciences' new Forecasting Science Centre, a central government think-tank, the mainland economy will become the world's third largest by 2010 even though its growth will slow slightly in the next five years. The report did not provide a figure for estimated economic growth this year but said it expected the economy to grow by about 8 per cent a year between now and 2010. The economy has grown by about 10 per cent a year over the past five years. Not everyone is as optimistic, however. Malcolm Wood, a regional equity strategist at Morgan Stanley, said the investment bank had downgraded the China sector rating to 'equal weight' from 'overweight', as most mainland stocks had already priced in the favourable factors. 'We believe the mainland economy will continue to perform well, but the problem is many counters such as Bank of Communications and China Mengniu Dairy have already reflected the positive factors,' Mr Wood said. Bocom has soared 41.84 per cent so far this year while Mengniu has surged 20.45 per cent, trading at 24.02 times forecast earnings. In the past month, Morgan Stanley had downgraded the mainland banking, consumer and telecommunications sectors.