Photographer: Anthony Kwan/Bloomberg

Asia's Hottest Stocks Look Set to Keep Rallying

  • Valuations, start of Shenzhen link to support shares: Mehta
  • Aberdeen Asset prefers city’s shares to China holdings

A rally in Hong Kong equities that’s made them the hottest in Asia is seen continuing through year-end, buoyed by increased access for mainland funds and a stabilizing Chinese economy.

The Hang Seng Index jumped 12 percent last quarter, its best performance since 2009, as flows through an exchange trading link with Shanghai swelled to a record and traders pushed back bets for higher U.S. borrowing costs. That was the biggest gain among Asian benchmark indexes tracked by Bloomberg.

While the advance has driven valuations on the city’s benchmark gauge to the highest in five years, the index is still 40 percent cheaper than MSCI Inc.’s measure of global shares on a price-earnings basis. A second trading channel with Shenzhen will start this year, increasing the amount of shares mainland investors can buy. Concern about China’s slowdown has ebbed after a string of data showed the economy is maintaining equilibrium.

“Hong Kong valuations remain supportive,” said Sandy Mehta, Hong Kong-based chief executive officer of Value Investment Principals Ltd. “The upcoming Shenzhen connect will also draw global attention to the market. Any boost to Shenzhen will drive Hong Kong."

Hong Kong’s $4.1 trillion stock market is recovering after turmoil in Chinese financial markets and fears of an economic hard landing sent the Hang Seng Index plummeting 36 percent in the space of 10 months. That dragged the gauge’s price-earnings ratio below 9 times in February to its lowest level since 2011. The measure now trades at 12.8 times reported earnings, compared with the MSCI All-Country World Index’s 21 multiple.

The Hang Seng Index climbed 0.4 percent, its highest level in a month and erasing an earlier loss of 0.5 percent.

While investors are growing more confident about the outlook for Hong Kong shares, with the Hang Seng Index climbing about 8 percent this year, the same can’t be said about their yuan-denominated peers. The Shanghai Composite Index is still down 15 percent as state intervention keeps the mood among local traders subdued. The widening gap is helping lure mainland funds into Hong Kong equities in the run up to the start of a new link with the technology hub of Shenzhen.

Aberdeen Asset Management Plc has an overweight position on the Hang Seng Index, the 50-member gauge which has Tencent Holdings Ltd., HSBC Holdings Plc and AIA Group Ltd. as its top weightings.

Risks Remain

"We are comfortable with valuation and quality of stocks," said Hugh Young, Singapore-based managing director at Aberdeen Asset Management Plc with assets of about $420 billion. "In many ways, we prefer it to direct mainland China exposure.”

Of course, there is no shortage of risks that could derail the rally. Hong Kong’s economy is on shaky ground, with a retail slump deepening amid falling visitor arrivals. Odds are increasing that the Federal Reserve will raise interest rates at its December meeting, which would result in higher borrowing costs in the former British colony thanks to the city’s currency peg with the greenback. Signs of frothiness in China’s housing market are prompting some analysts to predict policy makers will tighten monetary policy next year.

Tony Hann, the head of equities at Blackfriars Asset Management in London, is on the side of the skeptics when it comes to Hong Kong stocks. He says there is no guarantee that mainland funds will continue to support the market, while a "negative surprise or two" out of China may cause investors to change their bullish outlook.

Economic Data

"We are underweight Hong Kong and China," said Hann, whose Blackfriars Oriental Focus Fund has outperformed 94 percent of its peers this year with a 28 percent return. "No plans to change this. Hong Kong has benefited from increasing activity on the southbound leg of the Shanghai connect. It is not clear if this will be sustained through the fourth quarter."

Still, the latest economic data are adding to the upbeat tempo in Hong Kong. China’s official factory gauge stayed at the highest level in almost two years last month and its services index increased. The Bloomberg Intelligence China gross domestic product tracker rose to 7.16 percent in August.

"The economic backdrop is much healthier compared to a year ago," said Jing Ulrich, JPMorgan Chase & Co.’s Hong Kong-based vice chairman of Asia Pacific. "The current valuation of the Hong Kong market remains low. The launch of the Shenzhen stock connect is expected to attract more southbound funds from China."

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