BEIJING: Since the end of the financial crisis, Chinese stocks have been unable to shatter their glass ceiling. Even though shares have gained strongly this year so far, the market remains range-bound. The benchmark MSCI China Index, which includes Hong Kong- and U.S.-listed Chinese companies, has returned 11.3% this year, thanks to a flood of mainland Chinese money into Hong Kong. Through trading links with the Shanghai and Shenzhen stock exchanges, the Hong Kong bourse has received $7 billion, an average of $200 million a day, from its mainland neighbors so far this year. But there’s a little-noticed phenomenon at work. Since 2010, the MSCI China Index has traded in a range from 50 to 70, while turnover on the Hong Kong bourse mostly runs from $6.4 billion to $12.9 billion. When daily turnover exceeds $12.9 billion for a few days, it has usually signaled a market top. The only exception was during the spring of 2015, when mainland China’s stock markets rallied sharply, and Hong Kong shares were bid up, as well, on heavy volume.
Within this context, the recent run in Chinese stocks is hardly a bull sprint. The MSCI China Index hit its peak on Feb. 23 at 66, and the average daily trading volume is under $9 billion. To sustain its gains, Hong Kong will need more capital flows from the mainland, because foreigners have not bought into China’s recovery story yet. Actively managed funds are still selling. Goldman Sachs argues that the mainland money will keep coming, hitting $54 billion in 2017, a jump of two-thirds from 2016. At $19 trillion, the mainland’s investible assets are more than enough to buy out the entire Hong Kong market, which has only a $2.1 billion free float, the bank avers.
However, the Chinese mainland money flowing into Hong Kong isn’t the volatile retail cash that rushed into, and then out of, mainland stocks in 2015. To trade in Hong Kong, investors must be either institutions or high-net-worth individuals, and they tend to be well informed and cautious. Southbound flow tends to sell near the top of the range and buy at the bottom of the range. Case in point: Mainland investors have on balance been selling China Construction Bank (ticker: 939.Hong Kong), the most heavily traded stock on the Hong Kong Shanghai Connect, since the MSCI China index peaked on Feb. 22. While Chinese banks offer hefty dividends, investors worry they may start to sell new shares to take advantage of their high stock prices. Beijing has said state-owned enterprises can’t sell new shares at or below book, so investors take profits whenever market valuations move above book. This mentality also places a ceiling on MSCI China, where financials make up about 25% of the overall valuation.
