Hong Kong Plan’s Disappearing Act
IT ALL SEEMED TOO GOOD TO BE TRUE — and so it proved on Wednesday. Two weeks back, China’s forex regulator, the State Administration of Foreign Exchange (SAFE), had stunned Hong Kong by announcing that mainland retail investors would “soon” be allowed to put unlimited cash into Hong Kong equities via a single executor, the Bank of China (through offices in Hong Kong and the northeastern city of Tianjin).
Although no date was set, regulators said a trial project would be set in motion. Hong Kong’s financial markets greeted the news with predictable exuberance — the local Hang Seng index rose nearly 20% over the next ten days, breaking through the 24,000 mark for the first time. Local brokers rubbed their hands with glee, waiting for China’s citizens to start pouring some of their 17 trillion yuan ($2.3 trillion) worth of household savings into Hong Kong’s coffers.
THEN CAME THE SEPTEMBER 5 bombshell. Three officials at China’s banking regulator, the CBRC, summarily announced that Beijing was going to delay the trial run.
Rules would need to be put in place first, they said — placing a cap on total capital outflows allowed from the mainland — before the trial run could go ahead.The minimum level of investment necessary to take part in the scheme was raised to 300,000 yuan (US$40,000) from 200,000. Rumors sprang up that a cap of 500,000 yuan would also be imposed — to pre-empt an unmanageable outflow of investment from smaller or wildly speculative investors.
No one knows how long the delay of the trial run will be, however. Some brokers fret that Beijing might delay it until after China’s twice-a-decade National Congress, a political plenum that starts October 15 and runs for two weeks.
Beijing Bet: Hope that China would further loosen capital controls buoyed some Asian markets.
Meanwhile, Beijing’s flip-flop stopped the Hang Seng’s tumultuous rise. From Sept. 5, the index headed down, falling 0.3% Friday to close the week just below 24,000.
How did this muddle get made?
Some Hong Kong-based analysts said the trial run had been given too little prior consideration. Others suggested that Beijing got cold feet about the project when it saw how hysterically the news was welcomed in Hong Kong. The only consensus among Hong Kong analysts and brokers was that Beijing had made a big mistake.
The real irony here is that the trial run would probably benefit China more than Hong Kong.
Mainland China’s leading stock markets, in Shanghai and Shenzhen, are almost comically overpriced. Shanghai’s Composite Index has risen 98% in the year to Sept. 5, and by 356% since the start of 2006. And while the Hang Seng index is valued at a reasonable 16 times reported earnings, China’s largest 300 corporations are valued at an average 52 times reported earnings. The country’s markets are awash in cash, with millions of new retail accounts opening each month.
Allowing the trial run would, in theory, give the Chinese authorities a pressure valve, allowing capital to flow out of overpriced mainland stocks and into Hong Kong shares. “Frankly speaking, the central government just wants to channel excess liquidity out of the market, and this would have given them the chance” to do that, says Edgar Chuan, managing director of Descartes Investment Management, a Hong Kong-based institution with US$400 million under management.
Analysts say the other beneficiaries would be the 42 Chinese corporations with listings in both Hong Kong and Shanghai. Corporations such as insurer China Life (ticker: 2628.Hong Kong), lender Bank of Communications (3328.HK) or energy giant Datang International Power (991.HK) are well known to mainland investors, and they should see good growth in coming years; they are genuine value-creation stocks.
If the trial run is ever revived — a big “if” for the next few weeks, at least — the Hong Kong securities of these dual-listed firms will be the ones to buy. The stocks of all 42 dual-listed companies are cheaper to buy in Hong Kong than in Shanghai, in some places almost unbelievably so.
Analysts tip Datang as the most likely candidate for a boost; its Hong Kong shares are valued at 25 times reported earnings, versus 77.7 times in Shanghai. They also like the Bank of Communications, trading at 48.8 times in Shanghai and 27 times in Hong Kong. As well, several analysts see good prospects for Maanshan Iron & Steel (323.HK) at 31.6 times and 17.5 times, respectively.
For the truly adventurous, there is always Yizheng Chemical Fibre (1033.HK). While its Hong Kong securities are hardly languishing, valued at 312 times reported earnings, neither are its Shanghai shares, valued at a whopping 1,098 times earnings. But before investors can benefit from the discrepancy in valuations, Beijing must decide which path it wants to take to expand investing.
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