Everyone's long known that China's stock market is a rigged, non-transparent mess. That's a problem for Beijing certainly, but it's also now a problem for Hong Kong, once considered the gold standard for global financial hubs.
Many had hoped that Hong Kong's return to Chinese hands in 1997 would've prompted the Communist Party to try to import the city's first-world banking system, openness and rule of law. Eighteen years on, the opposite seems to be happening. China is exporting its financial bedlam to a city whose defenses may be woefully unprepared. Charles Li, the CEO at Hong Kong Exchange & Clearing, recently told Bloomberg News his market can easily handle the mainland inflows enabled by a new exchange link with Shanghai. What isn't clear is whether Hong Kong regulators have the capacity to monitor and contain the risks associated with all that cash sloshing across the border.
This week's events only reinforce those doubts. On Wednesday, solar company Hanergy Thin Film Power Group crashed, erasing a breathtaking $19 billion in 24 minutes. A day later, the chaos spread to the Goldin twins -- Goldin Financial and Goldin Properties -- which lost $21 billion, about half their market value, for no obvious reason. The three companies had been among Hong Kong’s best-performing stocks this year. Their downfall makes at least three things clear.
First, China's bubbles are now Hong Kong's problems. Mainland markets long ago abandoned the kind of value investing championed by the likes of Warren Buffett. Chinese punters care little about balance sheets, financial ratios or corporate strategy. What matters more are the links company officials are believed to have with top Communist Party officials -- who got in on the ground floor, whose nephew or niece is on the board and whose mobile numbers are in the CEO's contacts list.
Guanxi -- a term covering connections or relationships -- is valued above P/E ratios. Rather than looking at company filings, investors scour Internet chat rooms to find out which corporate titans appear to be blessed with official favor. I can't pretend to know why Hanergy's stock surged sixfold this year before Wednesday's plunge, or why the Goldin twins jumped more than 300 percent. Suffice it to say that investors believed more in the owners -- Hanergy's Li Hejun and Goldin's Pan Sutong -- than the businesses. Once that aura cracked, in Li's case because he chose not to show up to the company's annual meeting, everyone rushed for the exits.
Hong Kong officials now need to start thinking in these terms and bolstering their defenses, which currently don't even include so-called circuit breakers as in other major markets. The Securities and Futures Commission should increase its investigative and enforcement staff immediately. Authorities also need to reconsider the laissez-faire regulatory environment that's long set Hong Kong apart in Asia, increasing oversight of unusual share moves and intervening where necessary. Officials might want to consider slowing mainland capital flows until data on buy-and-sell orders can keep pace with trading activity.
Secondly, prospects are looking dicey in the solar sector. Fair or not, Hanergy's downfall will cast a pall over the renewable-energy realm. The crash coincided with one at Yingli Green Energy (down 37 percent in U.S. trading on Tuesday). Yingli now says there's "substantial doubt" over its future.
Granted, short sellers and media outlets had long questioned Hanergy's unproven technology, unconventional accounting regime and dependence on its parent for revenue. In December, analyst Charles Yonts of CLSA in Hong Kong asked rhetorically of Hanergy's claims to have mastered thin-film technology: "Are they really that good?" Now, executives boasting of renewable breakthroughs from Japan (which offers some of the world’s most-generous incentives for clean energy) to the U.S. will face new levels of market skepticism. China is, after all, where most of these innovations will be assembled. Even if issues at Hanergy and Yingli are company-specific, expect increased volatility in energy stocks for the foreseeable future.
Third, global investors should prepare for more uncertainty generally. Unprecedented central-bank cash is driving asset prices to record highs even as global demand underwhelms. China is a particular anomaly, with a stock market in the stratosphere despite the slowest growth since 2009. For better or worse, Beijing is likely to continue encouraging this stock bonanza because equity is about the only way companies can raise cash nowadays, given the debt overhang throughout the economy.
If fundamentals were driving things, Shanghai shares might be falling; instead they're up about 42 percent this year. Shenzhen shares are up even more, about 92 percent, and it's only May. The southern Chinese city will soon have its own Hong Kong market link, opening yet another channel for mainland money to overwhelm Hong Kong regulators. As Bloomberg News reported Friday, over 100 Shenzhen stocks have surged more than sixfold each over the last year. About the only sure bet in this market is that many of them will repeat Hanergy's swoon.
This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.
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