Hong Kong Hostage to China Rout Makes Stocks Too Cheap to Ignore

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As China’s efforts to tame its stock market cause turbulence in Hong Kong, some investors are focusing on the markets’ differences.

After tumbling the most since the financial crisis on July 8 amid a record surge in volatility, the Hang Seng Index rebounded Thursday to its biggest gain in three months. With the gauge near the cheapest versus global shares in more than a decade, Valkyria Kapital Ltd. is buying companies it says have been unfairly sucked into the mainland selloff. Close to half the Hang Seng Index, including companies from HSBC Holdings Plc to New World Development Co., trades below book value.

China’s officials have unveiled market-boosting measures almost every night over the past two weeks to reverse the rout in the world’s second-largest equity market. With about half of mainland stocks suspended from trading to shield themselves from the panic, sellers turned their attention to Hong Kong instead.

“I’m surprised by the extent of the negative reaction we’ve seen in the Hong Kong market,” said Manishi Raychaudhuri, Asia Pacific equity strategist at BNP Paribas SA. “This is the right time to take a look at fundamentals and not get carried away by this avalanche of selling.”

The Hang Seng Index climbed 2.1 percent on Friday, rebounding for a second day. It still fell 4.5 percent this week, the most in more than a year. The Shanghai Composite Index posted a 5.2 percent weekly advance after the largest three-week selloff since 1992.

Valuation Gap

The mainland gauge was about 33 percent more expensive than the Hang Seng Index on Thursday when measured by price to estimated earnings. The difference between Chinese shares listed in the city and in Shanghai was even bigger. The Hang Seng China Enterprises Index traded at 8.2 times projected profits, compared with 15.6 for the Shanghai measure.

More than 1,400 companies were halted on mainland exchanges, locking sellers out of half the market. Regulators late Wednesday banned major stockholders from selling stakes in listed companies. The police are investigating more than 10 institutions and people on suspicion of “maliciously” shorting blue-chip equities, China Securities Journal reported Thursday.

“By effectively removing the free activity in the mainland market, they’ve exported the weakness into the China Hong Kong market, which we are generally fans of,” Michael Shaoul, chairman and chief executive officer at Marketfield Asset Management, said on Bloomberg Television. “It’s a much more even playing field -- a much more honest institutional type of marketplace -- and unfortunately that’s been really the victim of the ham-fistedness of the Chinese authorities.”

Missing Out

While it’s been punished this week, Hong Kong didn’t enjoy the same rally as Shanghai on the way up. The mainland gauge more than doubled after China cut interest rates in November through its peak, as the Hang Seng Index gained just 16 percent.

LGT Group and AMP Capital Investors say Chinese shares listed in Hong Kong are attractive, while Valkyria Kapital sees opportunity in the city’s broader market. CLP Holdings Ltd., an electricity supplier, and Hong Kong & China Gas Co. were down at least 8.2 percent from their highs this year through Thursday. The MSCI Hong Kong Index of Hong Kong companies and Macau casinos dropped 9.5 percent from May 26 through Thursday.

“It’s the same thing that happens with these overshooting modes -- the correlation, everything, melts to one. What does CLP or Hong Kong Gas have to do with this?,” said Niklas Hageback, who helps oversee about $202 million at Valkyria. “I’ve never seen things this cheap. For a long-term investor this is fantastic.”

Net Sellers

The Hang Seng Index this week traded at the lowest price-to-book ratio relative to the MSCI All-Country World Index since

2003. Mainland investors were net sellers through the Hong Kong-Shanghai stock link for eight days through Wednesday.

“When we look back to these days six months from now, a year from now, they will be proven to be a great buying opportunity,” said Brett McGonegal, executive managing director at Reorient Group Ltd. “There’s not a fundamental reason why things have been cut just across the board. These opportunities present themselves very rarely.”

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