China halt gives investors new reason to shun Hong Kong stocks

[SYDNEY] The list of reasons for global investors to avoid Chinese shares in Hong Kong keeps getting longer.

Already beaten down by China's economic slowdown, a falling yuan and vanishing top executives, so-called H shares now face a new threat: the impact of circuit breakers on the mainland. The Hang Seng China Enterprises Index fell as much as 4.4 per cent on Monday after trading halts in Shanghai and Shenzhen spurred investors to shift sell orders to Hong Kong.

"Now it is up to Hong Kong to carry the burden, as traders who cannot sell their mainland portfolio will likely use Hong Kong," said Hao Hong, chief China strategist at Bocom International Holdings Co in the city, who called both the boom and bust in mainland share prices last year. "Many traders are disenchanted."

The H-share gauge plunged 19 per cent in 2015, leading declines in Asia, as the Communist Party's efforts to stem a rout in mainland equities had less impact across the border.

The government's sanction of a weakening yuan is exacerbating a deteriorating earnings outlook for Hong Kong dollar-priced shares as the economy slows.

An anti-graft campaign that's led to the disappearance or arrest of some of China's most high- profile corporate executives is adding to foreign investor concerns.

The H-share gauge is valued at the biggest discount versus the MSCI All-Country World Index since 2003, according to data compiled by Bloomberg. The measure trades at 6.9 times earnings, ranking it among the cheapest gauges tracked by Bloomberg after indexes in Zambia, Lebanon, Kazakhstan and Laos.

Chinese shares in Hong Kong were already declining on Monday after data showed the nation's manufacturing contracted for a fifth straight month. Losses escalated when a 5 per cent drop by the CSI 300 Index triggered a 15-minute suspension, and deepened further as trading was halted on mainland exchanges for the rest of the day.

Trading in Industrial & Commercial Bank of China Ltd, the nation's largest lender and the biggest dual-listed stock, illustrates the pattern. More than 16 million H shares changed hands in the minute that mainland stocks were halted for the day, or 6.2 per cent of the entire day's volume, data compiled by Bloomberg show. The stock touched its low of the day the same minute, falling as much as 4.5 per cent, before paring its drop to 3.4 percent at the close.

ICBC fluctuated in Hong Kong and the mainland on Tuesday, as the Shanghai Composite whipsawed between gains and losses. The index slid as much as 3.2 per cent at the open, before rallying 1 per cent less than half an hour later. The Hang Seng China Enterprises Index was little changed as of 10.12am local time.

VOLATILITY CONTROL

Hong Kong's bourse will introduce a volatility-control mechanism as soon as 2016 that would prevent an individual stock from moving 10 percent or more during a five-minute period, once a session. Stocks traded in the city aren't currently subject to any daily price limits.

Monday wasn't the first time investors have targeted Hong Kong amid shutdowns in mainland equities.

The Hang Seng China Enterprises plunged as much as 9.4 per cent on July 8, its biggest loss since 2008, as mainland officials allowed more than 1,400 companies to halt trading on the Shanghai and Shenzhen exchanges, locking sellers out of half the market.

Foreign banks were doubtful of the ability of China's new system to calm price swings. Goldman Sachs Group Inc. said circuit breakers won't notably reduce volatility given retail investors dominate turnover, while Citigroup Inc. said the mechanism is too conservative. The measures play an important role in stabilizing the market, and China will keep improving the system, China Securities Regulatory Commission spokesman Deng Ge said in a statement on Tuesday.

"The circuit breaker may increase selling pressure," said Castor Pang, head of research at Core-Pacific Yamaichi Hong Kong. When mainland shares get "halted, investors are using Hong Kong to hedge their positions."

BLOOMBERG