Markets

Christopher Langner is a markets columnist for Bloomberg Gadfly. He previously covered corporate finance for Bloomberg News, and has written for Reuters/IFR, Forbes, the Wall Street Journal and Mergermarket.

Like a full solar eclipse, the opportunity to test a theory of market efficiency in real time seldom arrives. Such a chance was presented on Monday when shares of China Vanke, the nation's largest developer outside state control, resumed trading in Shenzhen after a six-month suspension.

China Vanke's local-currency A shares plunged by the daily limit of 10 percent, even as their counterparts in Hong Kong climbed as much as 9.6 percent. The divergence is explained by a valuation gap that opened up since the Shenzhen shares were halted on Dec. 18 amid a hostile takeover attempt by Baoneng Group.

As the fight became increasingly complex and acrimonious, the Hong Kong shares -- which stopped trading for only two weeks -- dropped 29.9 percent. Investors locked into the Shenzhen stock could only watch. No wonder MSCI remains cautious about adding mainland shares to its emerging market indexes.

That Sinking Feeling
Holders of China Vanke's Shenzhen-listed shares could only watch as the Hong Kong stock plunged
Source: Bloomberg

Local shareholders were understandably quick to sell as soon as trading resumed. Arbitrage then kicked in and the Hong Kong shares rallied. Bingo: same company, same day, two exchanges just 17 kilometers (11 miles) apart, and completely opposite trading results. The trend may continue for several days, given that Vanke's A shares ended the day at the equivalent of HK$25.59, versus HK$16.22 for the Hong Kong stock.

Misaligned Stars
When trading on Vanke's shares resumed, they plunged, while the Hong Kong shares rallied
Source: Bloomberg
* Prices indexed to June 28 values for comparability.

The rare sight of a company's stock heading at such velocity in different directions is a reminder of the frictions, regulatory opacity and administrative whims that interfere with price discovery in China. Remove those barriers and prices adjust quickly, as market efficiency would dictate.

The phenomenon also serves to cast doubt on the solidity of mainland valuations. Other things being equal, stocks in Hong Kong -- with a more transparent and predictable regulatory regime that's less tolerant of arbitrary trading suspensions -- should deserve a higher rating. The opposite is the case. The CSI 300 Index trades at 14 times reported earnings, versus 6.9 for the Hang Seng China Enterprises Index of mainland shares traded in Hong Kong. Vanke's H shares are on a P/E of 8.4 times, compared with 13.3 times for the A shares.

After a swath of suspensions during last year's market crash, Chinese authorities have recognized the problem and have announced a three-month limit on halts. In the meantime, uncoordinated trading halts may create other opportunities for adventurous traders. There are at least three more dual-listed Chinese companies whose mainland shares are suspended while the Hong Kong securities continue to trade: Beijing Jingcheng Machinery, Dongjiang Environmental and Chongqing Iron & Steel.

Beware, though: Any profits will hardly be risk free. Anyone engaging in an arbitrage trade may wait for months or longer before a suspension is lifted. What's more, rules can be changed at any time. Like eclipse watchers, China investors also must try to see what's blocking out the light.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Christopher Langner in Singapore at clangner@bloomberg.net

To contact the editor responsible for this story:
Matthew Brooker at mbrooker1@bloomberg.net