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CNF Focus| Is the Hong Kong bull market coming?

Is the Hong Kong bull market coming?

Since 2021, the S&P 500 Index, the Nasdaq Index and the CSI 300 Index has risen 1.1%, 2.4%, and 5.1% respectively. The Hang Seng Index has risen by more than 10%, which stands out in the global financial market.

As of January 20, mainland funds have been net buying Hong Kong stocks for 21 consecutive trading days through Hong Kong Stock Connect, with daily purchases of more than HK$10 billion for 13 consecutive trading days. On January 19, the southbound funds net bought HK$26.6 billion in a single day, which is a record high. In less than three weeks this year, net inflow of southbound funds has reached HK$205.5 billion ,more than a quarter of last year. [1] It is worth noting that the net inflow of HK$672.1 billion for the year 2020 is already an all-time high since the opening of the Hong Kong Stock Connect.

Exhibit 1. Cumulative Capital Flow of Southbound Trading

Why are these funds optimistic about Hong Kong stocks?

1. The last valuation puddle

Under the negative impact of the COVID-19, central banks of various countries initiated easing policies, and the flood of liquidity has swept the world, causing divergence between global stock markets and economic data. In 2020, the S&P 500 and Nasdaq indices rose 16.3% and 43% respectively. The CSI 300 and ChiNext indices rose 27% and 44%, with other major global indices also performing well. However, the Hang Seng Index actually fell 3.4% in 2020, which is the worst performance in major global markets.

Among the global markets, European and American indices generally have a P/E ratio of more than 30 times, and the ChiNext index in China is as high as 68 times. Even the CSI 300 Index, which is heavily influenced by traditional industries, has a P/E ratio of 17 times. However, the P/E ratio of the Hang Seng Index (HSI) is only 16 times and the Hang Seng China Enterprise Index (HSCEI) is less than 14 times. What needs to be pointed out is that with the increase of new economy companies listed in Hong Kong, the HSI and the HSCEI are no longer the traditional indices that only consisted of financial and real estate companies. Tencent, Alibaba, Meituan, and Xiaomi accounted for about 20% of the weight of the two major indexes. After adding these new economy companies with higher valuations, the overall price-to-earnings ratio of the Hong Kong index is still the lowest.

There are many Chinese companies that choose to list in both the Hong Kong and A-share markets. Since the market environment and investors in the Mainland and Hong Kong are different, and A shares and H shares are not interchangeable, there are general differences in the stock prices of the same company in the two places. The Hang Seng Index Company compiled the famous Hang Seng Stock Connect China AH Premium Index based on the premium of A-shares relative to H-shares of listed companies in the two places. The index can be concise and intuitive to see the premium degree of the entire market. The index provides a concise visualization of the extent of the premium across the market.

Exhibit 2. Hang Seng Stock Connect China AH Premium Index

As shown from the chart above, the AH premium index was once close to 150 at the end of 2020, hitting a 5-year high. A company is listed in both A-shares and Hong Kong stocks, but the stock price in Hong Kong is nearly 50% cheaper, which shows how exaggerated the undervaluation of Hong Kong shares is. Even if the Hong Kong stock stock market has risen sharply in the past half month, the AH premium index is still at 133, which is higher than the average level in the past 5 years. Compared with the low points in previous years, there is still 20% room for repair.

2. The Great Boom of China Fund

In 2020, China's public funds issued more than 1,200 new funds, with net value growth of more than 4 trillion RMB. Private equity funds also have over 2 trillion RMB in new issuance. The funds raised have brought substantial incremental capital to the stock market. [2]

For the first half of January, the fund-raising speed didn’t slow down. The sentiment of investors to buy funds has even reached a new height. On January 18, Efund Feng Bo's new fund, with its raising cap of 15 billion RMB, attracted 239.8 billion RMB to snap up, setting a record in history.[3] At the same time, the newly issued products of other fund companies are also oversubscribed. Fund companies have to increase the speed of issuance to meet the demand of investors.

Exhibit 3. Market Value and Growth Rate of Hong Kong Stock Investments in Mainland Public Funds

When the fund capital raised the valuation of high-quality A-share companies to an exaggerated level, undervalued Hong Kong stocks became an choice worth considering. In 2020, the number of mainland public funds that can invest in Hong Kong stocks doubles from 739 to 1,572, and the issue size triples from $618.9 billion to $209.12 billion.[4] As more and more A-share public funds participate in the Hong Kong market, the investment style of mainland institutions will be intensified in Hong Kong stocks, and the value of quality assets in Hong Kong stocks will be further explored.

3. The uniqueness of Hong Kong stocks

The 2020 "Top 500 Listed Companies in China" list shows that as of December 31, there were 11 companies with market capitalization exceeding one trillion RMB, among which Tencent and Alibaba both listed in Hong Kong, ranked the top two for three consecutive year. In this list, there are 221 listed companies in Hong Kong stocks with a total market capitalization of over $40 trillion. [4] Therefore, Hong Kong stocks are a must for investors to take into consideration when looking for investment opportunities in Chinese core assets.

Since the reform of the Hong Kong IPO system in 2018, Xiaomi and Meituan have been listed in Hong Kong Stocks Exchange. Technology giants such as Alibaba, Jingdong and Netease have also returned to Hong Kong for secondary listing since 2019. Together with technology giants such as Tencent and SMIC which have been listed in Hong Kong for a long time, Chinese soft and hard technology giants have gathered in Hong Kong stocks. If investors want to participate in the investment of these core Chinese companies, they can only invest in the Hong Kong stock market and have no other choice.

Will Hong Kong stocks continue to rise?

On January 19, the turnover of Hong Kong stocks exceeded HK$300 billion, setting a new high since 2015. The turnover of Hong Kong Stock Connect was HK$990 billion, which also set a record.[5] The turnover of Southbound Fund accounts for more than 30% of the total turnover of Hong Kong stocks, which is the highest level in history.

Exhibit 4. Proportion of Southbound fund turnover in the total turnover of Hong Kong Stocks

With the increase in the inflow of southbound capital, the proportion of mainland funds in the market value and the turnover of Hong Kong stocks are increasing. Gradually, the market style and pricing model of Hong Kong stocks will move closer to A shares. At present, the average valuation of A shares is about 30% more expensive than Hong Kong stocks, and this premium may be further reduced in the future.

There have been similar cases in history. In 2017, when the valuation of quality companies in the mainland remained high, the net inflow of Hong Kong Stock Connect exceeded 200 billion that year and the Hang Seng AH premium index narrowed from 145 to 115. the Hang Seng Index rose 36% in 2017 and then reached 33,000 which is a record high. If the inflow of funds from Hong Kong Stock Connect continues, it’s highly possible that the Hang Seng AH premium index will continue to decline. When the AH premium index returns to a low of 115, the Hang Seng Index will hit another record high at that time.

However, it is important to note that over 60% of investors in Hong Kong markets are non-local investors and liquidity in Hong Kong stocks is largely generated from the larger economies. Once liquidity in the US and mainland China starts to tighten, the Hong Kong assets may be the first to be sold by non-local investors. The downside risk of Hong Kong markets when faced with macro changes is greater than that of the US and mainland China markets.

Conclusion

As Hong Kong and mainland markets become more closely connected and the funds flow more smoothly, the previous valuation gap between Hong Kong and A-share market will be gradually narrowed. This trend comes from the convergence of investment styles and risk appetite between the two places on the one hand, and from the valuation improvement of Hong Kong stocks due to the continued inflow of capital on the other. At present, there is no significant liquidity tightening in China and the United States, and the inflow of Hong Kong Stock Connect may continue for some time, so there is room for the Hong Kong market to rise.

If investors want to participate in the Hong Kong market, they can choose to trade Hang Seng Index Futures (HSI, MHI) and Hang Seng China Enterprises Index Futures (HHI, MCH). Investors who wish to invest in Hong Kong Stock Connect stocks can also trade stock futures provided by CN First Futures, including Tencent Holdings (TCH), China Mobile (CHT), Meituan (MET) and many other companies. Compared with the stocks, stock futures provide higher leverage and capital efficiency to facilitate investors to seize opportunities.

References

[1] 方凌,华尔街见闻《争夺“定价权”!史上第三次?》

https://wallstreetcn.com/articles/3617737#from=ios?ivk=1

[2] 陈肖,格隆汇,《南下资金为何疯了?》

https://m.gelonghui.com/p/440530

[3] 证券时报,《一天狂卖2398.58亿!打破新基金认购记录》

https://baijiahao.baidu.com/s?id=1689365249345256571&wfr=spider&for=pc

[4] IrisW,富途研究,《富途研究:2021年投资港股的9大理由》

https://news.futunn.com/hk/post/8525206?src=3&report_type=market&report_id=147475

[5] 富途资讯《港股收评:港股成交额破3000亿港元!为2015年来新高》

https://news.futunn.com/market/147554?src=1&user_id=12155378&utm_medium=futu_niuniu_share&utm_content=web_share&utm_campaign=news&utm_term=147554&data_ticket=e9a9ecabceacf12ec12421a9bec6f8bc

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2021/01/26
CN First International Futures Limited