The Hang Seng index pushed to a new 2016 high last week, and is up 14% since the United Kingdom voted to leave the European Union. The rally will have a lot more room to run if foreign investors can be convinced to return to China.
HSBC China strategist Steven Sun explains that recent gains “have been engineered by Chinese investors,” who have bought about 100 billion yuan ($15 billion) worth of Hong Kong stocks via the new trading link between Shanghai and Hong Kong exchanges (see “5 Hong Kong Stocks Set to Win from Shenzhen Link”). Mainland investors want yield, snapping up shares in China Construction Bank (ticker: 939.Hong Kong) and Industrial and Commercial Bank of China (1398.Hong Kong). They are also buying Internet conglomerate Tencent Holdings (700.Hong Kong), whose shares aren’t available in Shanghai.
Foreigners, however, are still sitting on the sidelines of the Chinese market, despite buying other major emerging markets in the last few months (see the Emerging Markets column). Year to date, they’ve sold $3.4 billion in China stocks and another $1.9 billion of Hong Kong companies’ stocks.
But sentiment could change. In the last week, foreigners turned net buyers, pumping in $912 million, the largest weekly flow in five months.
China may not be all that scary. Citigroup China strategist Jason Sun turned bullish on Chinese stocks last week, convinced “credit discipline” rather than a “credit boom” will help the market. Beijing seems determined to control corporate debt. By July, new corporate lending had fallen 8.2% year-on-year.
Chinese stocks can’t have a meaningful rally unless bank shares participate. On that score, UBS bank analyst Jason Bedford believes there have been at least five bank bailouts in the last year. Between 2013 and 2015, Chinese banks disposed of about 1.7 trillion yuan of impaired loans and raised 620 billion yuan in new capital, according to his figures. Much of this occurred at privately held banks and therefore went unnoted. UBS thinks Beijing needs to get rid of another 4.5 trillion yuan of bad debt. Still, it’s a start.
THE CONSENSUS is that banks’ bad-debt ratio, now less than 2%, will peak at 10% to 15%, so any chance it tops out at, say, 5%, would be a huge boost to Chinese banks, says Douglas Morton, Northern Trust Capital Markets head of Asia research. Morton is bullish on the banks because they offer excellent liquidity and 5%-plus dividend yields. They also are underowned by institutional investors, despite trading at 0.8 times book.
The Hang Seng’s rally isn’t all euphoria; this earnings season is unfolding nicely. Alibaba Group BABA -0.14432989690721648% Alibaba Group Holding Ltd. ADR U.S.: NYSE USD96.86 -0.14 -0.14432989690721648% /Date(1471640420582-0500)/ Volume (Delayed 15m) : 13934392 AFTER HOURS USD96.89 0.03 0.03097253768325418% Volume (Delayed 15m) : 332697 P/E Ratio 21.935366985981837 Market Cap 241692500941.516 Dividend Yield N/A Rev. per Employee 480267 More quote details and news » (BABA) reported its fastest revenue growth since going public, while Tencent set a new high last week after reporting fast growth on everything from mobile gaming to WeChat advertising. Ping An Insurance (2318.Hong Kong) saw its net profit grow 18% year-over-year, even as Chinese interest rates fell and the Shanghai stock market remained in its slump.
It isn’t hard to see why fund managers are tempted. Even after the recent rally, the Hang Seng Index has reached only a nine-month high, while the Hang Seng China Enterprises Index, or H-shares index, has broken even just this year, and trades at only 7.6 times earnings.
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