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Hong Kong–Shanghai Link–The New Great Rational Bull

China A share, ranked below US stock market,  is the world’s 2nd largest market in terms of the market capitalisation.  In the past, China mainland investors can only invest their monies in its A share (known as A Shares) and overseas investors could only tap into the China’s growth stories indirectly via China companies listed in Hong Kong (known as H Shares) or Qualified Foreign Institutional Investor (QFII).  Effective 2014-11-17, Hong Kong – Shanghai Stocks Exchange will be linked.  It meant, China mainland investors could invest in companies listed in Hong Kong and vice versa, i.e., Hong Kong investors could invest into China A share market.

The implications of this linkage are far reaching:

  • Historically, there is a price differential between China companies with dual listing - listed in Shanghai (A Shares) and Hong Kong (H Shares), where A Shares are traded at a premium to H Shares due to China’s strict capital controls to prevent arbitrageurs from buying shares of a dual-listed company cheaply in Hong Kong and selling them for more on the mainland.  From the AH premium index below, we observed that that premium has changed over the years – for instance, for the past months till now, AH has been < 100 which implied that A shares are trading at a discount versus H shares, but it is normalising.  The gap between the two will eventually be converged.

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Source:  Hang Seng China AH Premium Index Oct 2014

  • The broadening of investment universe.  It is worth noting that some sectors such as White Wine (e.g.五糧液,茅台) , Defence Industry, Home Appliance (e.g.海爾,美的,格力) and etc, are only investable by China mainland investors.  They would now be investable by the Hong Kong investors, diversifying their investment portfolios.
  • Convergent of Investor behaviour towards rationality.  Mainland Investors are characterised by  their emotional preference in small-cap and thematic stocks – as they believe small-cap stocks could run up faster than the large-cap and thematic would perform better due to high growth and earnings momentum.  Overseas investor, on the other hand, would favour large-cap as they are not familiar with the small-cap companies and neither would they accept expensive valuations of some thematic stocks.

It is worth noting that, China and Hong Kong Stock Markets have been underperformed for quite sometimes for various reasons.  In fact, in Feb 2014, China’s shares were even cheaper than Turkey, making it the cheapest major market in the world.

At the moment, H shares contributed about 16.8% to MSCI Emerging Markets Index.  With the continuation rise of the Chinese economy and its stock markets  - it is highly possible that MSCI Emerging Market Index would further increased its China’s weightage.  Thus, there is a good reason to believe that , the link could possibly earmark the beginning of the great “rational” Bull of Shanghai-Hong Kong market.

Reference:

  1. CNBC.com, Leslie Shaffer, 2014-02-10, “China is Now Cheaper than Turkey”
  2. Financial Times, Kylie Wong, 2013-11-15, “China’s A Shares Poised to Go Global”