Shanghai Rally Forecaster Now Favors Hong Kong Equities

When Bocom International Holdings Co. strategist Hao Hong turned bullish on China’s mainland stock market in September, he told clients concerned about the slowing economy to just ignore fundamentals and buy.

That call proved prescient as the Shanghai Composite Index posted its biggest quarterly rally in seven years on optimism authorities will take steps to revive growth. Now, Hong says the best way to make money in Chinese equities is by switching to Hong Kong-listed shares, which trade at the biggest valuation discount versus mainland peers since 2008.

The city’s so-called H shares are “unloved, under-discovered” and “represent a better investment opportunity,” Hong, 40, the Hong Kong-based head of China research at Bocom International, said in an interview. He predicts the benchmark Hang Seng China Enterprises Index will climb as much as 12 percent to 13,500 this year from yesterday’s close and sees the risk of a “correction” in Shanghai.

The H-share gauge’s 11 percent rally in 2014 lagged behind the Shanghai Composite by the most since 2000 as China’s domestic investors proved more optimistic about prospects for the world’s second-largest economy than those in Hong Kong. The widening gap has also divided analysts, with HSBC Holdings Plc and Credit Suisse Group AG siding with Hong Kong on H shares even as JPMorgan Chase & Co. and China International Capital Corp. say Shanghai stocks are a better bet.

The Shanghai Composite slid 0.2 percent to 3,285.41 at the close, while the Hang Seng China Enterprises measure advanced 0.5 percent to 12,081.24.

Property Alternative

Taking advantage of price differences between the two markets is getting easier since the start of the Shanghai-Hong Kong exchange link in November, with authorities set to allow short sales of mainland shares through the program this month.

The Shanghai equity gauge posted a world-beating 38 percent surge in the past three months through yesterday as the central bank cut interest rates for the first time in two years, the government pledged to open up state-owned enterprises to private capital and investors sought alternatives to a slumping real estate market.

“Even though economic fundamentals will continue to look weak, it is time to throw our senses out of the window, and buy the dips that will likely push new highs in the coming weeks,” he wrote in a report on Sept. 5.

Some of Hong’s peers say the mainland rally has further to run. A shares will probably outperform H shares “by a reasonable magnitude,” Adrian Mowat, the chief Asian and emerging market equity strategist at JPMorgan, said in an interview on Jan. 7. Chinese stocks will rise 30 percent this year as policy makers cut funding costs and enact reforms, according to Huang Haizhou, a managing director at CICC.

‘Huge Discount’

Chinese investors opened about 2.7 million accounts to trade stocks last month, the most since 2007. The value of shares changing hands on China’s two biggest exchanges exceeded 1 trillion yuan ($162 billion) for the first time on Dec. 5.

For Bocom’s Hong, mainland companies trading in Hong Kong offer better prospects. The Hang Seng China Enterprises gauge is valued at 8.4 times reported earnings, compared with the Shanghai Composite’s 15.7 times. Dual-listed shares were 28 percent more expensive in Shanghai than Hong Kong as of yesterday, according to the Hang Seng China AH Premium Index. PetroChina Co., the nation’s biggest company, cost 74 percent more on the mainland, data compiled by Bloomberg show.

“H shares are trading at huge discount to the A share market,” Hong said. “For a few months, there should be catch-up play.”

Price Gap

The H-share measure will climb 12 percent through year-end, compared with a drop of 5.9 percent for the Shanghai Composite, HSBC analysts led by Steven Sun wrote in a note this week.

Regulators may also scrap a rule forcing mainland investors to deposit a minimum of 500,000 yuan before buying Hong Kong equities via the link, HSBC said in a separate report. Chinese investors have used up just 5.5 percent of a 250 billion yuan quota to buy equities in the former British colony, according to data compiled by Bloomberg.

The widening performance gap between Shanghai and Hong Kong may persuade mainland and overseas investors to switch to H shares, according to Vincent Chan, the Hong Kong-based head of China research at Credit Suisse, which forecasts a 12 percent gain in the H-share gauge by year-end from yesterday’s close, versus a 15 percent decline for the Shanghai measure.

“At the moment it’s not happening,” Chan said on Dec. 23. “But at some point you can expect there will be some fund flow from A to H.”

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