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China returns at 5 times Hong Kong easy choice for investors

[HONG KONG] The divide in Hong Kong's stock market between the city's own companies and those that make most of their money in China will only get bigger.

That's the verdict of investors and brokerages from JPMorgan Asset Management to UOB-Kay Hian Holdings Ltd. who watched the MSCI Hong Kong Index rise 2 per cent last year as the Hang Seng China Enterprises Index jumped 11 per cent.

Monetary policy that favored Hong Kong since 2010 - stimulus from the US Federal Reserve and restraint from China's central bank - is reversing course, dimming the outlook for everything from casinos to developers and retailers.

"There will be much more downside for pure Hong Kong plays because people are buying China on a potential rate cut and a more stable economic outlook," said Steven Leung, director of institutional sales at UOB.

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"We don't see positive factors for Hong Kong. Toward the middle of this year there will be the risk of a US interest-rate hike, so people will continue to underweight pure Hong Kong plays."

The city's US$4.3 trillion stock market houses local companies, which make sales and borrow money in a currency that's pegged to the US dollar, and hundreds of Chinese equities influenced by policy across the border.

Last year, the Hang Seng China Enterprises Index outperformed the MSCI Hong Kong Index by the most since 2007. The city's equities remain more expensive, trading at 15.6 times estimated earnings, compared with 8 times on the H-share gauge, data compiled by Bloomberg show.

"If I look at the valuations, if I look at growth momentum, Chinese names do offer more interesting prospects," said Tai Hui, chief Asia market strategist at JPMorgan Asset, which oversees about US$1.7 trillion.

JPMorgan Chase & Co and China International Capital Corp are among those expecting more cuts to mainland interest rates and reserve requirements after the economy expanded 7.4 per cent last year, the slowest pace since 1990.

Gains in the H-share index accelerated after the People's Bank of China delivered a surprise rate reduction on Nov 21. The MSCI Hong Kong Index and the Hang Seng China Enterprises Index both retreated 0.1 per cent on Friday.

On the opposite end of the policy spectrum, some 45 per cent of economists surveyed by Bloomberg said the Fed will raise the benchmark lending rate in June. Higher borrowing costs would weigh on Hong Kong property stocks, which account for more than a quarter of the city's MSCI gauge, and are already facing government efforts to cool the real-estate market by increasing the amount of available housing.

"For the big constituents in the Hong Kong market like property, policy now is that we want to have more supply because that's what's good for the general population," said Joshua Crabb, head of Asian equities at Old Mutual Global Investors (UK) Ltd, whose parent oversees about US$123.2 billion.

The price target set by analysts on Sun Hung Kai Properties Ltd was nearly in line with the shares' closing price yesterday, data compiled by Bloomberg show. For Link Reit Ltd, analysts expect a 4 per cent drop.

The earnings outlook for gambling and retail shares is also weak as China's slower growth and crackdown on graft continue to discourage extravagant spending. Casinos led declines on the MSCI Hong Kong Index last year amid the first-ever annual drop in Macau gaming revenue, with SJM Holdings Ltd plunging 52 per cent and Galaxy Entertainment Group Ltd sliding 37 per cent.

Investment banks don't see a recovery any time soon, and have cut forecasts for Macau casino receipts this year. Nomura Holdings Inc expects gross-gaming receipts to plunge 19.6 per cent after earlier estimating an 8 per cent drop, while HSBC Holdings Plc's projection swung to a 7 per cent decline from a 6 per cent gain. SJM fell 7.4 per cent this year, with Galaxy declining 6.3 per cent.

Hong Kong's retail sales growth by value at the end of November was less than a third of what it was at the start of last year, according to the most recent data available. Jewellery chain Luk Fook Holdings (International) Ltd said same-store sales in Hong Kong and Macau dropped 6 per cent last quarter because of pro-democracy protests. The city's peg to the US dollar may also push visitors to cheaper destinations, said JPMorgan Asset's Hui. Luk Fook fell one per cent this year.

"Some Hong Kong retailers are struggling with a weaker consumer market here on lower spending by mainland tourists because of curbs on corruption and China's economic slowdown," said Louis Wong, director of Phillip Asset Management (HK) Ltd, which oversees about US$200 million.

Leon Goldfeld, investment director at Amundi Ltd, sees a bright spot for Hong Kong's market in Cheung Kong (Holdings) Ltd and Hutchison Whampoa Ltd, among the biggest advancers this year on the city's MSCI equity gauge. The stocks both jumped 17 per cent through yesterday since billionaire Li Ka-shing on Jan 9 announced a US$24 billion proposal to merge and spin off the real-estate assets of his two main companies. The MSCI Hong Kong index posted a 5.5 per cent advance this month, compared with a 2.2 per cent drop for the H-share index.

Chinese shares sank on Thursday after the Xinhua News Agency reported a mainland regulator was planning a new round of checks into the margin-lending businesses of brokerages. More scrutiny will create volatility, although it's ultimately good for capital markets, said Steven Rees, global head of equity strategy at JPMorgan Private Bank, which oversees about US$1.1 trillion. The Shanghai Composite Index plunged the most since 2008 on Jan 19 after regulators suspended China's three biggest brokerages from adding margin accounts.

There is further upside for H shares, which are trading near the biggest discount to their mainland counterparts since October 2011. This will prompt investors to sell local stocks and pick up cheaper China shares available in Hong Kong, said Dickie Wong, an executive director of research at Kingston Financial Group.

"The real interest is still on the China market rather than Hong Kong," said UOB's Mr Leung. "We will see more policy from the government on the economy and there is still a chance for China to provide more liquidity through RRR or interest rate cuts."