Chinese companies trading in Hong Kong have better value than their onshore peers amid signs the domestic market has become overheated after a world-beating rally, according to BlackRock Inc.
The biggest asset manager globally prefers the cheaper Hong Kong-listed H shares, especially small and medium-sized companies. Stocks benefiting from domestic demand and the nation’s structural reforms will become winners, while the yuan-denominated A shares, which have more than doubled over the past year to the highest since 2008, appear “frothy,” the New York-based investment firm said in an e-mailed report on June 8.
Chinese stocks have advanced as the government eased monetary policy to revive growth and implemented reforms to rebalance the economy by focusing on consumption instead of investment. While the benchmark gauge for H shares also rose to a seven-year high as the mainland rally spread to Hong Kong, the valuation premium for onshore companies over their dual-listed offshore peers has widened to 40 percent, from 2 percent in mid-November when an exchange link between Shanghai and Hong Kong began.
“We see value in H shares of selected banks, property developers, utilities and new energy,” BlackRock analysts led by Jean Boivin wrote. “This is not a buy-and-hold market. It’s about rapid sector and stock rotation. Consumption is likely to grow faster than GDP as China rebalances.”
China’s finance ministry this month cut import taxes by half on consumer products including clothing, cosmetics and baby items to lure Chinese to spend more at home rather than abroad amid attempts to stimulate consumption. Gross domestic product is projected to expand this year at the slowest pace since 1990.
The Shanghai Composite Index has surged 153 percent over the past 12 months, the best performance among major global equity markets. The gauge climbed 2.2 percent to 5,131.88 on Monday, the highest since January 2008. The Hang Seng China Enterprises Index, which mainly includes the nation’s big state-owned companies, has gained 36 percent in the past year to 14,113.98.
Companies on the underperforming Hong Kong gauge are trading at about 10 times forward profit on average, compared with a multiple of 19 for the Shanghai index, the highest since 2009.
The premium on smaller companies over large-cap stocks is narrower in Hong Kong than in the mainland, partly because there is less liquidity in the offshore market, according to BlackRock. That will change as the integration between the two markets deepens, the firm said.
The iShares China Large-Cap ETF, the largest Chinese ETF in the U.S. tracking Hong Kong shares, gained 0.9 percent to $49.41 on Monday in New York, while the Deutsche X-trackers Harvest CSI 300 China A-Shares ETF jumped 3.3 percent to a record $54.72.
A Bloomberg index of the most-traded Chinese companies in the U.S. sank 1.3 percent to 136.04, paring its gain for the year to 25 percent. China Biologic Products Inc. tumbled 12 percent, the most in two years, after the plasma-based pharmaceutical company filed to sell 2.5 million shares in a secondary offering.
John Burbank, chief investment officer of global investment firm Passport Capital, is also bullish on Chinese offshore stocks. He recommended buying the American depositary receipts of companies that are listed on exchanges in the U.S. in an interview last week as the government cut rates amid low inflation, fueling liquidity in the equity markets.
“We prefer Chinese ADRs, generally of leading Internet companies,” Burbank said. “In general we think China is in an up-trend. And a lot of positive changes are happening there.”