Shanghai-Hong Kong Valuation Gap Narrows on Stock Arbitrage Bets

Jul 28, 2014 4:20 am ET

July 28 (Bloomberg) -- The valuation difference between Chinese shares traded in Hong Kong and Shanghai narrowed by the most in five months amid growing speculation that an exchange link between the two bourses will lure arbitrageurs.

The Hang Seng China AH Premium Index climbed 1.9 percent to 91.90 today, signaling a narrowing gap between dual-listed stocks. The Hong Kong stock exchange said the start date for the exchange link has not been set, after the National Business Daily reported it would begin on Oct. 13. The Shanghai Composite Index rose 2.4 percent at the close as trading volumes surged to the highest levels since Sept. 11. The Hang Seng China Enterprises Index gained 0.7 percent and entered a bull market after rebounding 20 percent from this year’s low.

The exchanges agreed in April to allow cross-border trading, opening up the mainland market further to foreigners while giving wealthy Chinese investors a route to buy Hong Kong stocks. Valuation gaps between the two exchanges had reached the widest since 2006 on July 23 as mainland investors exited the stock market and international money managers awaited details of the exchange tie-up.

“Mainland big-cap shares are cheap and quite low in valuation and there have been some arbitrage opportunities,” said Wang Weijun, a strategist at Zheshang Securities Co. in Shanghai. “The stabilization of the economy has also fueled the buying sentiment.”

The Shanghai Composite posted its biggest gain since March 21, led by banks, brokerages and coal producers, amid growing optimism the government will achieve its economic-growth target for this year after accelerating railway spending, allowing cities to loosen property curbs and cutting reserve-requirement ratios for some lenders.

Sell Stocks

Xi’an and Wuxi have become the latest cities to ease restrictions on home purchases, according to domestic media reports over the weekend, while data yesterday showed industrial profits jumping 18 percent in June, compared with 8.9 percent growth in the previous month.

The rally for Chinese stocks in Hong Kong and Shanghai is being driven by hype and investors should pare holdings, Hao Hong, the chief China strategist at Bocom International Holdings Co., wrote in a report today. He said the central bank’s 1 trillion yuan ($162 billion) pledged supplementary lending was an “accounting sleight of hand” and that investors have become overly optimistic. The People’s Bank of China has yet to confirm use of this facility.

Preparatory work for the stock connect plan is making “good progress,” with market rehearsals arranged for brokerages in late August and September to verify readiness, the Hong Kong stock exchange said in an e-mailed response to questions today.

Exchange Link

The Shanghai stock exchange disclosed the October start date for the link in a brokerage training session, reported the National Business Daily. An exchange press official said he wasn’t aware of the start data when contacted by Bloomberg News.

“The Shanghai and Hong Kong exchange link is having a fairly big impact on the A-share market as lots of institutions anticipate significant money inflow,” Lu Wenjie, a strategist at UBS AG, said by phone today from Shanghai. “It makes sense that money has been allocated to big-cap, blue-chip stocks such as financial companies.”

Industrial & Commercial Bank of China Ltd. jumped 2.3 percent in Shanghai, compared with a 1.5 percent advance in Hong Kong, after it announced plans to raise as much as 80 billion yuan by selling preferred stock in China and offshore. The lender’s yuan-denominated A shares are trading at a 17 percent discount to the H shares, according to data compiled by Bloomberg.

Financial Stocks

ICBC and Ping An Insurance (Group) Co.’s A shares were recommended by UBS AG China strategist Chen Li in a report last week, citing their “deep discounts” to H shares. Ping An, China’s second-biggest insurer, surged 3.3 percent in Shanghai, while gaining 1.2 percent in Hong Kong. The A shares trade at a 19 percent discount, Bloomberg data showed.

A measure of financial companies in the CSI 300 Index jumped 4.1 percent, while the broader gauge rose 2.8 percent. Bank of Communications Co. soared 9.9 percent after Reuters reported that the lender wants to sell more stakes to private investors as part of China’s economic restructuring.

Citic Securities Co. and Haitong Securities Co., the largest-listed brokerages, surged at least 4 percent after Hong Yuan Securities Co. announced it had agreed to merge with Shenyin & Wanguo Securities Co. for 39.6 billion yuan in stock.