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Why China Bears Are Buying Chinese Stocks
Chinese companies’ Hong Kong-listed ‘H-shares’ are surging as mainland money pours in
YIP/REUTERS
By MIA LAMAR
Sept. 23, 2016 2:17 a.m. ET
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Foreign investors are loath to own Chinese stocks. Few strategists think the economy is turning a corner. But a message is developing: Buy the stocks anyway.
After spending the first seven months of the year in the red, the Hong Kong-listed shares of Chinese companies—known as H-shares—have clawed their way into positive territory with a 10% surge since July, and some savvy investors see further gains.
The reason: An enormous rush of cash from investors in mainland China who are snapping up Hong Kong shares—cheaper and higher-yielding than those at home—via the city’s stock-trading link with Shanghai.
Even after the recent rally, companies in Hong Kong’s Hang Seng China Enterprises Index, which tracks H-shares, are trading at just 8.4 times what analysts expect them to earn in the coming year, compared with 13 times for yuan-denominated “A-shares” in Shanghai and a whopping 34 times for stocks on China’s tech-heavy Shenzhen Stock Exchange.
For the likes of Grace Lu, a former China stock picker for Singapore state investment giant Temasek Holdings Pte Ltd. who now runs hedge fund LyGH Capital, that means investing in Hong Kong stocks right now is simply a matter of following the money.
“There is a good chance for the Hong Kong market to go further higher even though global investors’ sentiment on China [is] still subdued,” Ms. Lu said in a note to her investors this month.
Hong Kong stocks now make up 40% of her portfolio, up from 10% two months ago and a negative position earlier this year, she told The Wall Street Journal.
So far in September, mainland investors have bought a net 49.4 billion yuan (7.4 billion dollars) in Hong Kong shares through the trading link, more than three times the monthly average this year. A fresh wave of money could be coming: Among the investors recently given Chinese authorities’ green light to use the link are the country’s massive insurance companies.
Investors and strategists say mainland investors are looking more to Hong Kong for investment opportunities in part because conditions at home are no longer favorable.
“Market conditions in China are different than two years ago. At that time, equity was cheap, bond yields were high, property prices were not that outrageous,” Ms. Lu said in an interview with The Wall Street Journal this week. “Now…China asset prices are generally all very expensive and renminbi-depreciation expectation is very high.” “Renminbi” is another name for the yuan.
“Most of the liquidity isn’t coming from international investors,” she added.
Ms. Lu has made some well-timed calls in the past. Concerned by Chinese companies’ sluggish earnings and a potential flood of stock as a ban on initial public offerings was lifted, Ms. Lu in late 2015 went into bear mode.
She cut her fund’s net exposure to rising markets to just 10%, she said, well below the 60% net exposure or even higher that many China funds maintain. This paid off in January, when a sharp selloff sent Chinese shares listed in Hong Kong tumbling 15% and those listed in Shanghai down 24% in U.S. dollar terms. Ms. Lu’s fund slipped 1.8% after fees, according to investor materials seen by The Wall Street Journal.
‘To be clear, it’s not about the Chinese economy, which will continue to struggle’
—Lim Say Boon, DBS Bank
So far this year, the 85 million dollars fund has gained 13% after fees, according to investor materials, outperforming Chinese stock indexes and some of Ms. Lu’s larger rivals.
Other investors are making similar bullish calls on Hong Kong despite their China doubts. Lim Say Boon, chief investment officer of DBS Bank, repeated some earlier advice this week, urging his clients in a note to “follow the money” and buy H-shares.
“To be clear, it’s not about the Chinese economy, which will continue to struggle,” Mr. Lim said. “Our call at midyear was driven by low valuations and expectations of policy support. And both factors remain valid.”
The Hong Kong rally could stall if mainland support for the city’s stocks were suddenly to dry up—and indeed the buying spree hit a speed bump Thursday as the trading link recorded its first day of net outflows from mainland investors since Aug 1.
Global investors wary of China’s slowing economy and opaque companies have been reluctant to step up buying of Chinese shares this year despite a far-reaching emerging-market rally that boosted stocks from Pakistan to Brazil.
Others warn that Hong Kong shares are getting less cheap by the day, particularly given the possibility the U.S. Federal Reserve will raise interest rates this year, which would dent the higher-yielding bank and property shares that have been particularly popular with mainland investors
“The flow coming to Hong Kong I think is very sustainable, but I think we are past the really cheap-valuation stage,’ said William Ma, chief investment officer of wealth manager Noah Holdings Ltd. “What we need is an earnings recovery instead of just being cheap.”
—Gregor Stuart Hunter contributed to this article.
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