And so we have it, the big opening of the Shanghai – Hong Kong Stock Connect! The morning session has been traded, and this step of opening of the Chinese capital account is underway! I will get into the market signals a bit later, for now I’ll try to bring up the structural features of the trading link and where you can find good information for yourself.
As was partially expected, the skew was large in favour of China. Bloomberg reported some more on the actual numbers and tried interpreting them. I would say that given that foreigners are yet to be allowed to sell the securities they acquire through northbound trading on the Stock Connect, it is pretty natural that the trading is one-sided. Add to this a pretty bad day on the Hong Kong exchange overall (thanks, Japan…) and the allure of going global surely didn’t seem all too big.
The display of performance divergence during the morning today is a pretty good illustration of the point another Bloomberg article tries to make: Shanghai Stock Exchange stocks are not particularly correlated to global stocks. This makes them attractive to money managers elsewhere, as it allows construction of new portfolios with a wider range of situations that they can perform well under relative to highly correlated western markets according to CAPM, the Capital asset Pricing Model. Now… I don’t want to be throwing the whole industry under the bus, and at the moment these people happen to be going with the right sentiment, but probably for the worst possible reasons. They could potentially get it right performance-wise if China starts becoming more friendly to shareholders, but the irony of it all is that then the correlation will most likely fade. I’ll explain this in better detail after I give you a few hints of where to find good information on the exchange link, since this is rather multi-faceted and involved.
I missed this little gem prepared by the HKEx. It’s a great summary sheet of things that will be interesting for the average investor, and it’s succinctly illustrated to be quickly grasped. I wish I could do stuff like this… It contains good information on the types of traded shares you’ll have access to, how big the turnover is, some good relevant comparisons, sector breakdowns and Top 10 turnover and market cap sheets. It’s a good little trading guide going forwards, and the massive volume in Shanghai is definitely looking like an interesting addition to the Hong Kong turnover dynamics in the longer run.
aastocks.com’s new Shanghai – Hong Kong Stock Connect portal really deserves a plug as well. As always with aastocks.com you get good analytics, great visualization, and quick news. This is always my go-to for the Hong Kong market, and it looks increasingly like it will open up to become the access point to the Chinese market as well. How I wish that Japan would get into the game and join the link as the Japan Exchange Group wanted to… Anyway, I can’t recommend aastocks.com enough, even though their current portal page for the quota seems a bit broken at start. Don’t fret: there’s live data on their home page, updated every minute as most banners there are.
So, what about the problems with the correlation of Chinese shares? Structural under-performance!
China isn’t beholden to the current ways of the world for two main reasons:
- There is as of yet not too much capital on a GDP basis committed to stocks as I have written about previously, and equity investors are far down the line of things that China cares about. Reform, development and improving lives for people to uphold the influence-for-riches social trade-off that the Chinese people implicitly have are much more important things, and there are no pension funds or insurance sellers that require the broad capital appreciation potential of any big, liquid markets as of yet. These institutions would really change the conditions on which the Chinese wealth increase is predicated.
- China’s stimulus is done differently. First, it is larger when need be (more access to savings capital and a less indebted government) and generally both quicker (PBOC is basically the financing arm of the CCP after all) and targeted towards development much more than the financial markets. This leads the Chinese equity cycle to look rather different, and coupled with the whole idea of the non-importance of equity markets, returns have been subdued. One of the best examples of this would be the long-term charts provided yesterday, comparing the HSCEI and the HSI side by side. Let’s show it again:
Hang Seng Index:
Hang Seng China Enterprises Index:
A large part of China’s non-correlation is simply under-performance! When the S&P500 (which makes up a large part of Bloomberg’s favourite MSCI world!) was cheered on for US growth that doesn’t necessitate stimulus and hitting all-time-highs, China was in two minds about whether to do more or less stimulus, and just how hard to clamp down on extravagant spending (and lending, too, without clipping the wings of growth). We just recently bounced from very, very low levels, and to look at exactly what and how I recommend you to look up my chart on China A50 from yesterday.
China is simply uncorrelated to the global equity markets for the same reasons that my account performances in Macau are uncorrelated to the equity markets: both are high risk gambles with money largely expected to be lost and pretty much a way to pay an entry fee to the gate keepers. When the market changes structurally to absorb larger investors, and when it invites foreigners in to any larger extent, there will be societal reasons to buff up the stock market, and the Shanghai Stock Exchange performance would be at the mercy of international capital market flows to the same extent as any other markets. The very feature of isolation from the rest of the financial system is what provides the lack of correlation, and the more you link it, the more correlation you will get.
Plowing money into China using the Shanghai – Hong Kong Stock Connect “because CAPM said so” is possibly the dumbest thing I’ve read in a long time. Look at the performance metrics, look at the underlying features of the stock market, look at China’s reform- and development paths, look at how stocks are priced at the moment, and then come back to me and tell me you have an investment insight. Don’t tell me “because the market was down when everyone else was throwing money at theirs forcing those markets up, we think that the China market will go up when everything else is down”. See the issue? Hopefully you see the comedy at least!
I think China will generally act counter-cyclically, to an extent that most global politicians can only wish for, but there is a lag, and that lag CAPM won’t capture, instead looking like noise. Also, the “IPO” of China’s equity markets will have a honeymoon period where the “green shoe option” of expanding the Shanghai – Hong Kong Stock Connect is debated, but China has notoriously been tough on its equity markets, and if there are gains to be made, they will largely go to fulfilling China’s needs, not ours as global investors. (Click this link for an example of when this is comically evident, courtesy of Bloomberg and ASIFMA.) We’re just lucky if we’re on the right side of the trade.
It feels funny for me to say this: look at the fundamentals (China’s prospects, needs and structure), not the technical analysis (CAPM). Never thought I’d slam CAPM for being bad technical analysis when all its proponents talk about its brilliance because of relying on at least weak-form market efficiency!