Small and medium-cap stocks have increasingly followed the pattern of mainland A shares, driven by the influx of hot money from mainland China.
The Hong Kong market is more mature and the trading mechanism has led to steep declines in some stocks that lack fundamentals.
Hanergy Thin Film Power Group (00566.HK), Goldin Properties Holdings (00283.HK), Goldin Financial Holdings (00530.HK) and Yan Tat Group Holdings (01480.HK) have suffered sharp price falls.
Foreign investors have lost faith in some stocks. Coupled with weak economic data, the recent slide in stock prices is hitting A shares hard.
A sound regulatory regime is key to transforming A shares into global plays.
The price correction in smaller stocks could help cool the red-hot market but investors should continue to watch out for the potential risks.
Beijing is determined to deepen economic restructuring and reform, which could be a catalyst for some stocks related to state-owned enterprise (SOEs).
SOEs that have been embroiled in the government’s anti-corruption campaign might benefit from restructuring or consolidation.
Also, inefficiency has led to long-term losses for some central SOEs and prevented them from turning their monopoly status into an advantage.
Further reform is necessary to beef up their competitiveness and shore up their balance sheets.
China CNR Corp., CSR Corp. and China Resources have shown that central SOEs will be the main market theme in the next one to two years.
However, investors should first target companies with poor balance sheets.
For example, China’s railway sector has the highest debt ratio, so any consolidation will help address any financing issues.
Also, mainland banks that have sought a public listing to obtain market funding offer a viable model for central SOEs.
The worst sector might be the best target for speculation because they have limited downside given the central government’s support.
The potential upside will be enormous if they complete consolidation and get publicly listed.
I like the prospects of red chips in the shipping, new energy, healthcare and agricultural goods sectors.
Investors could collect a basket of relevant stocks. These are likely to benefit from every industry reshuffle and bring desirable returns in the short and medium term.
Mutual recognition of funds between Hong Kong and the mainland will happen in July, opening new channels for Chinese and international markets to merge.
This comes on top of Shanghai-Hong Kong Stock Connect and the forthcoming stock link with Shenzhen.
The move is part of efforts to speed up the inclusion of the renminbi in the SDR (special drawing rights) basket and promote the internationalization of the Chinese currency.
Mutual recognition might benefit the mainland market more as happened to the Shanghai stock link.
The mainland market has wider fund choices and higher returns, potentially boosting A-share funds and A-share ETFs.
Also, it will help Hong Kong’s ambition to become an asset management hub in the region on the back of the mainland’s growing economic power.
However, it might be unrealistic to expect the Chinese market to be dominated by various funds given these account for less than 20 percent of the stock market in the mainland.
The benefits of mutual recognition will be felt much more when foreign investors become bullish about A shares again.
If nothing else, it’s a step in the right direction that will benefit the Hong Kong market in the short to medium term.
Also, mutual recognition of funds will help create new jobs in the financial sector, in turn boosting banks and brokerages.
The commercial housing sector will also benefit as more mainland funds set up offices in Hong Kong.
Investors could include commercial property in their portfolios for rental and value appreciation, or they could buy property stocks whose underlying assets have a high percentage of office properties in their portfolios.
These include Hysan Development (00014.HK), Swire Pacific (00019.HK) and Champion REIT (02778.HK).
This article appeared in the Hong Kong Economic Journal on May 26.
Translation by Julie Zhu
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