China H-Shares Trade Like They're in Zambia as Bulls Get Crushed

  • Index sinks most this year among global peers as growth slows
  • Hang Seng China is cheapest versus world equities since 2003

It was all going so well for Chinese stocks in Hong Kong.

Just seven months ago, the Hang Seng China Enterprises Index was surging to the highest levels since 2008 and strategists couldn’t raise their targets quick enough. Now, the gauge of so-called H shares is tumbling at the fastest pace among global peers, analysts are downgrading their forecasts and valuations have dropped to levels approaching those of Zambia.

Even by the volatile standards of emerging markets, it’s a dramatic fall from grace for stocks that bulls had expected to surge as China cut interest rates, opened up cross-border capital flows and revamped state-owned companies. Investors have instead been driven away by weak economic growth and an anti-graft campaign that led to the disappearance or arrest of some of China’s most high-profile corporate executives.

"I was fooled," said Hao Hong, the chief China strategist at Bocom International Holdings Co. in Hong Kong. "Cheap is not enough."

While Hong was one of the few analysts to call both the start and peak of this year’s boom in domestic Chinese shares, his forecast for gains in Hong Kong-listed equities proved too optimistic. Hong now says the Hang Seng China index will be stuck in a trading range.

Many of his peers have also turned more downbeat. Societe Generale SA, which predicted in March that the Hang Seng China index would rally 17 percent by year-end, says the gauge will be flat in 2016. Goldman Sachs Group Inc. downgraded its outlook for Chinese shares to marketweight from overweight in a report this month.

Selling by investors, meanwhile, has dragged down the H-share index by 37 percent from this year’s high in May, the steepest drop among equity gauges in the world’s 50 biggest markets.

It now trades at 6.9 times earnings, lower than every benchmark index apart from Zambia, the southern African country facing a economic crisis, and Laos, which only has four listed equities. The Hang Seng China gauge is valued at the biggest discount versus the MSCI All-Country World Index since 2003, according to data compiled by Bloomberg.

Depressed valuations are luring bargain hunters from across the border. Mainland investors have been net buyers of Hong Kong stocks through the city’s exchange link since Nov. 27, while technical indicators suggest a rebound is overdue. The Hang Seng China gauge’s relative strength index was 28 on Monday, below the 30 level that some traders use as a signal to buy.

The H-share index rose 0.3 percent to 9,344.07 at the close. The Hang Seng Index, which also includes Hong Kong companies, fell for a ninth day in its longest losing streak since 1984.

Not all Chinese stocks listed in the city are doing badly. Investors have flocked to companies seen as beneficiaries of President Xi Jinping’s attempts to transform the drivers of China’s economy from investment to consumption and services. Tencent Holdings Ltd., operator of the WeChat messenging service, and Byd Co., a maker of electric cars, are among so-called new economy companies that have rallied more than 30 percent in 2015.

Bulls took solace from data on Saturday showing unexpected strength in China’s old growth drivers and renewed vigor in the new ones. Industrial output climbed 6.2 percent in November from a year earlier, compared with the 5.7 percent median estimate in a Bloomberg survey, while retail sales gained 11.2 percent for the best reading of 2015.

While there is some evidence of economic stabilization, China’s slowdown is likely to continue through the first half of 2016, according to Francis Cheung, a senior strategist at CLSA Ltd. who turned negative on Chinese stocks in June. Growth will probably weaken to 6.4 percent next year from a decade average of 10 percent, according to Goldman Sachs.

Corruption Probes

"The only way that H shares can perform is if there’s better momentum in the economy," Cheung said in a Dec. 10 conference call in Hong Kong. "The economy is not going to stabilize in 2016."

Concern that the government’s crackdown on graft will ensnare more corporate executives is also turning investors away, said Alex Wong, who helps oversee $150 million as a Hong Kong-based asset-management director at Ample Capital Ltd.

More than 30 senior executives of listed Chinese companies have gone missing or faced government investigations this year, according to the state-run Securities Times. Fosun International Ltd. shares sank 9.5 percent on Monday after the company said its billionaire chairman was assisting judiciary authorities with a probe. Agricultural Bank of China Ltd. President Zhang Yun resigned for “personal reasons,” the lender said this month, after people familiar with the matter said he was taken away to help with a state inquiry.

"People want to cut their exposure in China to reduce their risk," Wong said.

Soured Loans

The Hang Seng China index’s heavy weighting in financial and commodity companies will be a drag on the gauge as bad loans increase and raw-materials prices sink, according to Daniel So, a strategist with CMB International Securities Ltd. in Hong Kong.

Banks account for about 41 percent of the overall index weighting, while energy companies comprise another 11 percent. China’s troubled loans swelled to almost 4 trillion yuan ($619 billion) by the end of September, more than the gross domestic product of Sweden, according to the industry regulator. Oil has tumbled 39 percent in New York over the past 12 months to its lowest level since 2009.

The index "is dominated by Chinese banks and commodity miners, which I’m bearish on," said So, who doesn’t have a target for the gauge and prefers consumer companies and insurers. Any rebound would be "very difficult" to sustain, he said.

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