HK's Hang Seng Exuberance

The Hang Seng index coupled with the H-share index have been outperforming every other Asian markets for the past 6 months. Much of it can be attributed to the spillover effects from the Shanghai and Shenzen bourses. However, the real factors behind HK's sizzling market performance go deeper than that. Let's start with the China factor. Many HK companies are an indirect play into China, but without the lofty valuations of stocks in Shanghai or Shenzen. The closed up China markets to foreign investors have brought a huge group of investors and fund managers to HK, hoping to get a slice of the action by buying HK shares with business exposure in China and the ridiculously discounted H-shares.

Many are wising up to the fact that H-shares discount will eventually narrow substantially. The A-share price have traded at 40%-60% premium to H-shares with no sound fundamental reasons except demand is higher in the mainland. If the status quo stays forever, then the discount is warranted. But H-shares are being "asked" to also list in Shanghai in order to help satisfy the demand for good shares back in the mainland. The other thing is H-shares are necessarily "better shares" already by virtue of passing the hurdles set by HK Exchange. They are much bigger, better visibility and have a good record in corporate governance and transparency. The H-share factor brings in long term players who are willing to ride the boom and see the discount being worked down eventually.

The H-shares have also provided a huge boom in the related warrants trading. Warrants trading in HK, mainly driven by H-shares, are in the top 3 in the world. Watch how the money trickle down. It used to be that HK only makes money 3 ways: tourism, property and stocks. Now it also acts as a conduit to China, a strong supply-chain consultant to China, a huge capital center to tap for investing into China, and in more ways are complementing each other's economic model rather than competing with one another. The huge jumps in China's income per capita have prompted mainland visitors to HK in droves, one of the biggest factor driving the HK economy back to life following the difficult period in 2003-2004.

The fact that its currency is still pegged to the USD caused enormous pain to HK during the 97-2000 financial crisis in Asia. By holding onto the peg, many industries were priced out and had to close. All other Asian currencies lost about 40%-60% in value, that made the HKD stick out like a sore thumb. Structural unemployment was a big consequence in HK, only high value add industries can survive. However, the peg is also what is helping HK's financial markets NOW. The weak and weaker by the day USD basically cause HK to gain back some competitive edge. The faster the Federal Reserve cuts rates, the more significant will be the positive effects for HK's economy, especially in tourism and property.

It is the only market with the potential for significant capital inflows from Chinese mainland investors. Looking all around Asia, the rich companies and rich individuals are mostly stuck in mainland China, and is likely to see more capital being recycled back into the HK economy over the next 12 months. The HIBOR should go down by 100-150 basis points over the next 6-9 months, which would lead to negative real rates. Historically, such an environment has been a big positive for the economy, property developers, and banks. Also, Hong Kong historically has been the best-performing Asian market during Fed rate cut cycles.

The many new rules and regulations made with respect to QDII and the allowance for individual investors to invest directly into HK listed shares are just indicative of the liquidity and potential liquidity driving the bull. All said, the weak USD has made stocks much cheaper in the US and HK, creating a strong platform for higher equity prices.