Tuesday, April 21, 2015

Week Ending 4/25/2015: The PLA is Coming

When discussing the H-shares market, "the PLA is coming (解放军来了)"  is a fun phrase being tossed around. One gets the image that Chinese money is amassing at the HK border, ready to "liberate" Hong Kong stocks. In reality, this pool of money will likely not only come from mainland China, but from the global investment community as well. In that case it might be more fitting to say  "the Eight Nation Alliance Army (八国联军) is coming". But of course, that ended up in a humiliating defeat for China, so "the PLA is coming" is a better phrase.

In my previous post, I mentioned that momentum and sentiment is in favor of the HK stock market, but did not elaborate much beyond the valuation discrepancies between A vs H shares. Here are some points to add on the liquidity/technical side (and signs that "PLA" is indeed amassing at the border)

  • People are literally smuggling money into HK
  • Talks of lowering the minimum account size for retail investor to participate in SH-HK Connect (current minimum is about ~80k USD)
  • New rules to contain A shares, such as making shares easier to short, signals the government's plan to further reduce limits of arbitrage.
  • Fund managers are forming Shanghai-HK connect funds to "go south" and take advantage of the A-H arbitrage
  • A separate Shenzhen to HK connect will start later this year.
We now have a great backdrop for HK stocks to appreciate. You already have cheap absolute valuation on various single names, and cheap relative valuation versus their A-share counterparts. But now a wave of liquidity is coming. Macroeconomics could surprise to the upside as well. Right now the China macro picture is rather conservative, dominated by talks of slower/quality growth, temporarily lower consumption due to corruption crackdowns..etc. But macro could surprise to the upside if policies start to work (loosening monetary policies, One Belt-One Road initiatives...etc) late this year.

That's much better than the U.S. picture, where you have a fully valued stock market pumped up by all time high margin debt and high 2016E expectations, all while corporate earnings are slowing.

There is another sign that capital is be amassing at HK. The USD:HKD exchange rate is at it's limits (see below). It's not impossible that one morning we wake up and found that HK decided to break its USD peg.


Recent Moves: Piling in. Let Liquidity Be a Catalyst.

I have piled into HK stocks. When the market spiked in early April, I promptly doubled down on my winners in HK, added a few more names and even bought 2 ETFs. Within the past 2 months, HK stocks went from 0% to 20%+ of my portfolio equity. That is a huge move by my standards, and I'm sitting a bit uneasy. It does not help that despite the big market run up, my profit is small due to subsequent adds at higher prices.

The work now shifts back to the fundamental side. At the end of the day, you still have to buy good companies at good prices. What this all means though, is that if I see a solid company at a reasonable prices, I'm willing to buy without any fundamental "catalyst" to unlock value. Liquidity could be its own catalyst.

ETFs:  2833.HK and CHXF 

I bought two ETFs to position for 1) A vs H share price discrepancy narrowing, 2) increased liquidity.

2833.HK is the Hang Seng Index ETF. It is way too heavy on financials and property for my taste.

To balance that out, I also hold CHXF (WisdomTree China Dividend ex-Financials Fund). This is a U.S. listed ETF that invests in H-shares but excludes the financials and properties sectors. Roughly 45% of holdings are dual listed stocks trading at steep discount to their A-share equivalents. More than 95% of holdings are eligible stocks under the SH-HK program. Average LTM P/E is in the low teens. This seem to me a less risky vehicle for the A-H valuation arbitrage.

Over the coming months my plan is to gradually replace these with single names as price discrepancies narrow.

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