Be greedy when others are fearful
as Warren Buffett may or may not have said. Either way, when it comes to Chinese equities, this is sound advice. The -30% slide in the Shanghai Composite index over the last month stunned a market in which greed had been pumped up to stratospheric levels by a 153% rally over the previous 12 months. As with all previous leverage-propelled booms, the runup eventually rolled over into a deleveragingdriven crash. Unsurprisingly the attendant volatility has instilled investors with a greatly heightened fear of owning Chinese stocks.
At first glance, international investors did not need to worry too much. As far as most were concerned, the sell-off in onshore Chinese Ashares was an isolated event, given that foreigners owned only a tiny fraction of domestically-listed equities. But as the slump intensified, Asian companies which depend on Chinese demand, or that are proxies for China’s growth, found themselves increasingly vulnerable to selling pressure. Japanese tourismrelated stocks, Korean exporters and Australian miners all tumbled much more than their respective home markets.
Meanwhile, mainland investors, who had been caught off-guard by the wholesale suspension of A-shares and the bans on stock sales imposed by Chinese regulators, turned to the Hong Kong market as a cash machine. Unable to monetise their onshore portfolios, they cashed in shares acquired through the Hong Kong market as a liquid alternative. This dynamic explains, at least in part, why repatriation flows from Hong Kong to mainland China through the Shanghai-Hong Kong Stock Connect channel have surged to more than RMB1trn a day in the last two weeks, reversing the usual direction of travel. At the same time, the Hang Seng China AH premium index soared to a six year high of 149, indicating that Ashares were valued at a 49% premium to their Hong Konglisted counterparts.
Yet, although valuations in Hong Kong may now look attractive, investors remain fearful. Although Beijing has done its utmost to assure the domestic market that The Xi Jinping Put is firmly in place, the administrative support measures announced on July 11 have created almost as many fears as they have quelled. The Unequal Sell-Off In Chinese Stocks, which could have been a healthy deleveraging process, has been badly distorted by official intervention. With a quarter of Shanghai A-shares still suspended, there are widespread doubts about what will happen when trading resumes. And now that the authorities have torn up the rulebook, it will inevitably take time to rebuild confidence in the onshore market and to re-establish Beijing’s commitment to free market principles. In the meantime, the A-share market’s inclusion in MSCI and FTSE benchmarks will remain on hold.
On the other hand, the direct economic impact of the A- share crash will be small, given that less than 7% of China’s urban population own stocks. The Chinese property market appears to have entered a recovery cycle, which reduces the risk of a hard landing. And policymakers have opted to maintain currency stability, and are acting judicially to support economic activity rather than throwing caution to the winds in an all-out bid to re-ignite growth. Against this backdrop, good quality companies are still good quality, but are available at a marked down price.
Hong Kong-listed companies are especially interesting. Beijing’s heavy-handed intervention has highlighted Hong Kong’s strengths as a deep, transparent, well-functioning market; a safe place for investors who want a piece of China. The notion that Shanghai or Shenzhen can replace Hong Kong as China’s international financial center has been put back by years. With Hong Kong-listed shares at their cheapest relative to global equities in more than ten years, there are plenty of solid stocks that have been unfairly sucked into the mainland’s slump. Time to get greedy.