China investors go missing from Hong Kong stock-trading link

[HONG KONG] One year after China allowed some of its citizens to directly trade Hong Kong shares for the first time, enthusiasm has turned to apathy.

Since a flurry of buying by mainland investors in April spurred the biggest monthly rally in six years for the Hang Seng Composite Index, average daily purchases of the city's stocks via an exchange link with Shanghai have tumbled 89 per cent.

Four of the five most popular targets through the connect are down more than 40 per cent from April peaks, while the valuation discount on Hong Kong shares relative to Shanghai is even wider.

For Bocom International Holdings Co's Hao Hong, inflows are unlikely to pick up any time soon, because mainland investors prefer to chase rallies on their own exchanges and are happy to pay up to do so. While foreign traders see cheaper shares as opportunities to pick up bargains, he says in China such equities are seen as less attractive.

"The two markets have different rules of engagement," Mr Hong said. "They just don't see eye to eye." The stock connect, which authorities plan to expand to China's smaller exchange in Shenzhen, is part of the country's effort to open financial markets to the rest of the world and boost global usage of the yuan. The link has been a success from an operational standpoint, handling more than US$320 billion of turnover through October without any notable technical glitches, Hong Kong Exchanges & Clearing Ltd Chief Executive Officer Charles Li said in a blog post this month.

MAINLAND BUYING

April's surge in Hong Kong investment through the link coincided with the boom in mainland shares.

Daily average buying turnover of the city's stocks rose to a record HK$7.57 billion that month, driving a 15 per cent jump in the Hang Seng Composite. That figure slumped to HK$843 million a day in October after the Shanghai rally turned to a rout.

CRRC Corp, China's biggest maker of railway equipment, was the top-traded Hong Kong stock through the link over the past 12 months, according to data compiled by HKEx.

After surging 46 per cent in April, the shares have since tumbled 36 per cent. Beijing-based Gome Electrical Appliances Holding Ltd., the second-most popular, has slumped 43 per cent from this year's high on April 13. Haitong Securities Co fell for five straight months after rallying 35 percent in April.

LIMITED CONFIDENCE

While Chinese investors are regaining their confidence in mainland equities following an unprecedented rescue effort by the authorities, it will take time for traders to return to Hong Kong stocks, according to Gerry Alfonso, a sales trader at Shenwan Hongyuan Group Co in Shanghai.

"After a correction it is difficult for investors to start looking into a market that they are not too familiar with," Mr Alfonso said.

The Hang Seng Composite gauge climbed 1.9 per cent at 9.40am local time, rebounding from a six-week low. The Shanghai Composite rose 1 per cent.

The advance in Shanghai stocks, which bounced back into a bull market this month, has helped widen the valuation premium over Hong Kong shares. The Hang Seng China AH Premium Index of price gaps weighted by market value shows a 42 per cent gap, up from an historical mean of 17 per cent, and the widest level in two months.

For Mark Mobius, chairman of the emerging-markets group at Franklin Templeton Investments, the gap between the two markets is likely to remain "in the near or medium term" while China maintains restrictions on money flows across its borders.

"Valuations between the two markets will eventually narrow, but not until China fully open its capital account," Mobius said.

The premium enjoyed by mainland equities may be deterring international investors, who have sold stocks in Shanghai for 20 straight days in the longest stretch of outflows since the program began. The gaps also reflect growing pessimism among foreigners amid weaker-than-projected economic data, an eighth straight quarter of disappointing earnings and lingering concern about the government's interventionist response to the selloff earlier this year.

Momentum indicators also show the diverging performance of mainland and Hong Kong equities. While the relative strength index of the Shanghai Composite Index has climbed to 63, approaching the 70 level that some traders consider to be overbought, the Hang Seng Composite's RSI has fallen to 42, its lowest level in two months.

The planned launch of a stock link between Shenzhen and Hong Kong is unlikely to be more successful in luring investors from the mainland as long as they see the city's market as difficult to trade, according to Wu Kan, a fund manager with JK Life Insurance Co in Shanghai.

"Mainland investors struggle to make money in Hong Kong," Mr Wu said. "The mentality of investors in the two markets is different."

BLOOMBERG