The catch-up in the Hong Kong market could run for a little longer as valuations in that market are lower than their Chinese counterparts. The Hang Seng is still trading at below its long-run average and A-shares are still at a premium to H-shares. Until that gap closes, demand will persist.
“Bad news is good news” as far as China’s economy goes. Economic growth is slowing faster than Chinese officials might want, with increasing expectations of further rate cuts from the People’s Bank of China and fiscal stimulus measures from the government.
Finally, the market may be supported by flows. The quota on the Stock Connect may be extended and, given the difference in size between the A- and H-share markets, there is still plenty of pressure forcing capital through that system. Meanwhile, some funds may be forced into buying Chinese equities, if only to keep up with benchmarks. China accounts for 22 per cent and 24 per cent of the MSCI AC Asia Pacific ex Japan Index and the MSCI Emerging Market Index, respectively. So any benchmark-focused investor who has been underweight China could now be forced into buying shares.
But once the arbitrage opportunities have faded, investors will need to see tangible evidence of significant improvement in China’s economic fundamentals and corporate earnings. Without this, the rally could be very short term indeed and prove not to be the sheep with the golden fleece after all.
Kerry Craig is global market strategist for JP Morgan Asset Management
