Hong Kong’s ‘cheap’ equity valuations could mean this rally has further to run, analysts say

Daily turnover on the Hong Kong stock exchange exceeded HK$100 billion on Wednesday and Thursday, more than double the daily averages of January and the daily averages for 2016.

Where’s all this money coming from? And is the inflow sustainable? And since China’s currency regulator has attempted to restrict the inflow of mainland capital into Hong Kong, how can this be happending?

The rally may be the result of mainland funds -- earmarked for overseas acquisitions -- which are seeking a temporary refuge in Hong Kong pending Beijing’s approval for overseas deployment, said Morton Securities’ chairman Joseph Tong Tang.

“These companies have the green light to invest in Hong Kong stocks before their overseas investment projects get approved,” Tong said. “That has benefitted Hong Kong’s stocks.”

Fresh capital flows into Hong Kong have slowed to a trickle since the Chinese currency regulator enacted a series of measures last year to deter capital flight, amid a 7 per cent deterioration of the yuan against the US dollar. As a result, outsize takeovers and acquisitions have come to a halt, while Chinese companies and individuals are reporting anecdotes where their remittances into Hong Kong are coming under extra scrutiny.

Still, an escape clause exists, as the Stock Connect programmes allow Hong Kong and mainland Chinese investors to trade in each others equities, providing a channel for Chinese capital to buy Hong Kong shares.

Hong Kong’s benchmark Hang Seng Index is trading at 13 times current year earnings, while the Hang Seng China Enterprises Index, which tracks H shares of Chinese companies, is even cheaper at 8.6 times.

That makes Hong Kong the cheapest in price-earnings terms among Asia’s 15 stock markets, lower than the 21.6 times on the S&P 500 Index, or 52.8 times on the FTSE 100. China’s stocks are expensive by comparison, with the Shanghai A-share index trading at 18.4 times 2016 earnings, while the Shenzhen A-share index of technology-heavy stocks trade at 44.7 times current year earnings.

“As the valuation gap widens between mainland China shares and Hong Kong, this has provided an arbitrage opportunity,” said Ada Ng Yuk-ip executive director of Sun Hung Kai Financial.. “Investors are taking advantage of the price gap, and are rushing to invest in H-shares in Hong Kong.”

Add to that the Hong Kong currency’s peg to the US dollar, which compels the Hong Kong Monetary Authority to maintain a lockstep interest rate policy with the US Federal Reserve, which has telegraphed three more increases in rates this year. The sum total is a stronger Hong Kong dollar vis-a-vis the yuan amid the cheapest market valuations in Asia. That’s acting as a magnet for regional funds, brokers said.

“The yuan is expected to fall in the long term, so Chinese companies and individuals will continue to invest in Hong Kong’s stock market to escape their valuation loss,” said Jasper Lo, chief strategist at King International. “The hot money is going to stay for at least a couple of months.”

Among the winners are consumer and energy stocks, because they’ve been beaten down for so long, making them perfect bargains for the rally, traders said.

Want Want China Holdings, the Taiwanese maker of snacks, instant noodles and beverages, has risen 12.6 since the start of 2017, while Hengan International Group, a producer of sanitary napkins and diapers, has gained 15 per cent.

“We seldom see such large price increases for these undervalued sectors,” said Eastspring Investments Asia equity portfolio specialist Ken Wong. “Potentially this is a result of investors trying to find attractively priced sectors and stocks that are trading substantially below their intrinsic value.”

The proportion of mainland Chinese investors using the Stock Connect programme to buy Hong Kong stocks represent 10 per cent of all the entire market’s turnover in February, compared with only 3 per cent a year earlier.

The Hang Seng A-H Premium Index, which tracks the gap between the A-shares listed in Shanghai or Shenzhen and their counterpart H-shares in Hong Kong, has fallen to 118.14 on Thursday, from a high of 154.11 in July 2015.

The excitement may be a flash in the pan, as China’s economy still must muddle through what promises to be a challenging year for exports and corporate earnings, Lo said.

“Investors should pay attention to the risks in the market, as China still faces an economic slowdown,” said Lo.