Analysts confident shrinking southbound money flow will regain momentum

Mainland investors appear to have lost their appetite for Hong Kong stocks, as southbound capital flow through the Shanghai-Hong Kong Stock Connect dropped sharply, the week after resumption in trading following the week-long “golden week” holiday.

Analysts expect the flow to recover soon, but it may not be blue-chips or be significant enough to shore up the benchmark Hang Seng Index, analysts say.

Mainland money passing through the Shanghai linkup channel to Hong Kong dropped to 1.54 billion yuan (HK$1.77 billion) on October 11, when trading resumed, compared with a daily average of 2 to 3 billion yuan in late September.

It continued falling during the following week, to just 32 million yuan on October 17 and 68 million yuan on October 18.

The numbers are in stark contrast to market expectations that a resumption in trade after a week’s break would spark higher flows than last month.

“That capital flow is very much in line with current market sentiment. There’s just no good reason to buy at the moment,” said Hong Hao, managing director and chief strategist with Bocom International.

Strengthened expectations of a rise in US interest rates in December, and a more stabilised A-share market have also made Hong Kong stocks less attractive, especially when the blue-chip benchmark stands at its highest level this year, above 24,000.

“The Hang Seng Index has jumped 5,000 points within three months and its level of 24,064 [on October 11] was a peak for most investors,” said Kenny Wen Kit, wealth management strategist at Sun Hung Kai Financial.

The yuan’s depreciation also made Hong Kong-listed mainland companies even more expensive, as their prices are denominated in Hong Kong dollar, while earnings are counted in the Chinese currencies.

“Mainland companies contributed 70 per cent of the Hong Kong stock market’s earnings. The yuan’s drop is a clearly negative factor, but that was neutralised by high expectations for the Shenzhen-Hong Kong Stock Connect ...investors chose to ignore some factors from time to time,” Hong said.

Among the most actively traded stocks under the stock connect, Bank of China jumped over 15 per cent from July to early October, but has now shed 2 per cent since October 11.

Tencent Holdings shares soared 23 per cent up in past three months, but lost 3 per cent since the golden week holiday.

Some profit taking on blue chips was expected, Wen said, but that doesn’t change the general expectation that more mainland capital will flow to the city.

Hong is confident of the daily 2-3 billion yuan southbound inflow daily average returning, as that’s “in line with Beijing’s hopes of reducing the risk of bubbles in property market”.

”And there is no capital outflow concern, because the southbound capital is still in a closed loop under the connect scheme.”

However, some market watchers do not expect any fresh money flows to shore up the Hang Seng Index.

Hong Kong Exchanges and Clearing chief executive Charles Li Xiaojia has said the soon-to-be launched trading link would start trading on a Monday after mid November, indicating a likely kick off on November 21 or 28.

The new link will allow international investors to trade 880 Shenzhen stocks via Hong Kong brokers while mainland investors will be able to trade 417 Hong Kong stocks via mainland brokers, including around 100 stocks with minimum capitalisation of HK$5 billion traded in the Hang Seng Composite SmallCap Index, which are not included in the Shanghai connect scheme.

“Price to earnings ratio of such stocks are over ten times, but in Shenzhen, similar stocks are priced at 30 to 40 times P/E,” Tam said. “Dividend yield of such Hong Kong listings was around 2 per cent while in Shenzhen it was almost zero.”

Wen said the Shenzhen linkage will attract a different type of investor from the mainland, and less institutional players who have tended to dump a lot of cash into blue chips in previous months.

“Retail investment in technology and new-economy stocks hasn’t really started yet. The amount of capital they have is far less than institutions, but they are likely to be short-term investors who can push up market sentiment and turnover, whereas institutions tend to adopt ‘buy and hold’ strategies.

Tam said the “impact of the Shenzhen-Hong Kong Connect is yet to be fully priced in”, adding the major fundamentals that support continuous southbound capital flow remain unchanged.

She said that comparatively cheaper valuations and higher yields of local stocks, as well as mainlanders’ desire to diversify their assets as the yuan depreciates, should mean the Shenzhen link will increase capital flows significantly, as will the yuan’s depreciation, although investors may not be interested in blue chips.

But both she and Wen said the increase in mainland retail investors in Hong Kong is likely to add volatility to the market.