Macro Commentary
And now the two have connected. For the first time since being established, the quota for the amount of investment coming south through the conduit between the Shanghai and Hong Kong (Hang Seng) stock exchanges (called the HK-Shanghai Stock Connect) hit its limit. Approximately 10.5bln CNY ($1.7bln) flowed into the Hang Seng from Chinese investors looking for value after the local A-share market has continued a run to almost 100% over the past twelve months. Even as recently as last month, the amount of capital coming out of China was reported to be around 10% of the limit. That changed after a decision two weeks ago to let Chinese mutual funds buy stocks through Stock Connect without first acquiring a license. The local Chinese equity market (often called the A-share market) has historically been a retail-driven exchange as opposed to developed equity markets where a majority of trading is institutional. In the past, the rise and fall of the volatile market has coincided with the pace of new stock accounts being open and margin balances both of which have risen again. Perhaps the best illustration of the participants in the A-share market is a recent study by Bloomberg which showed that 30% of new equity investors in China have an education level of elementary school or less and that only 5.7% of new account openers have an undergraduate degree. The rise of the A-share market created momentum which carried the P/E level from a low 9.5x in June 2014 to 17.5x in March 2015 (thus, multiple expansion has been the primary source of return). With a new outlet for Chinese equity investor money, they are seeking the lower relative valuation in Hong Kong. Whether you look to the broader Hang Sang index (at 10.5x P/E) or the more comparable Hang Seng China Enterprises index (at 8.8x), there is meaningful relative value despite these indices rising 16% this year closing the gap relative to the A-share market (though at 20% and 40% returns over the trailing year respectively, they remain far behind the A-share return nearing 100%). While capital flow is clearly coming into Hong Kong, so may also be volatility. The A-share market is a volatile place where momentum eventually ceases and a correction ensues. While we continue to favor the fundamentals of our emerging Asian consumer theme and feel that the recent uptick in our implementation through Hong Kong has not caused valuation to extend too far, we are keeping a watchful eye.