Hong Kong share prices will see more volatility this year, driven by fluctuations in the flow of capital from mainland China through the so-called Stock Connect programs with exchanges in Shanghai and Shenzhen, CLSA chief equity strategist Christopher Wood said.
“The southbound flow will continue to pick up this year. You can see that it has started to happen, based on the data in January,” Wood said in Hong Kong on Tuesday.
Capital flow from China is becoming increasingly influential on the Hong Kong stock market, he said. Investors should pay more attention to the relative volume of southbound turnover compared with Hong Kong stock exchange (HKEx) turnover.
“We had a spike in the third quarter of 2016 and a collapse in the fourth quarter. Right now, we are having another spike,” he said. “It changes the dynamics and will make the Hong Kong markets more volatile.”
The Shanghai–Hong Kong Stock Connect program started in November 2014 with a southbound investment quota of 10.5 billion yuan (US$1.53 billion) per trading day and a northbound quota of 13 billion yuan. The Shenzhen-Hong Kong Stock Connect program kicked off last December with a similar quota system.
In the fourth quarter of last year, Shanghai-Hong Kong Stock Connect’s southbound turnover was 3.5% of HKEx turnover, down from an average 5.2% in September, according to Bloomberg data. The capital flow surged to a record of 7.9% on December 30 and hit 6.1% on February 3.
H-shares are overweight
Wood said he has recently upgraded H-shares to “overweight” from “underweight” as the Chinese stocks are undervalued at 12 times forward earnings, compared with 16 times globally.
“I don’t think the biggest risk is monetary tightening from the People’s Bank of China. The biggest risk should be that my view on supply-side reform is wrong,” he said. Fortunately, there are no signs that the Chinese government will slow down its supply-side reforms, given that such policy meets the country’s objectives to reduce excessive capacity and pollution, he said.
Last October, the government began to tighten policies towards the property markets in big cities as speculators are dominating transactions.
“That was prudential tightening. We are now seeing property transactions and prices slowing down,” Wood said.
“The pickup in prices in big Chinese cities earlier last year wasn’t caused by an easing but was caused by a relaxation of previous tightening policies,” he said.
As long as the Chinese population keeps following closely the “traffic light,” which refers to the government’s signalling on property policies, the risk in China’s property markets should be manageable, he said.
He added that whether A-shares will be included in the MSCI’s key emerging markets index may not be as important as the potential opening of China’s debt markets, in which foreign investors only account for 2%.