China stock shakeout creates most divided market in 15 years

Bloomberg

All Chinese stock indexes are not equal. As Beijing intensifies a campaign to clean up markets and
reduce leverage, state-owned enterprises that dominate old growth industries, such as banks and commodity producers, have been among the worst hit, while new-economy shares remain in favor among overseas investors. That’s led to a yawning gap between the nation’s two main offshore gauges — Hang Seng China Enterprises Index and MSCI China Index.
The 40-member Hang Seng measure has fallen 1.4 percent over the past month, as the MSCI China advanced 2.2 percent. That’s caused the index of so-called H shares to trade at its biggest discount against its MSCI rival in 15 years — a split that investors see diverging further.
“The stocks that are listed in the H-share market are typically the more mature, less high growth companies which you would expect to trade at low multiples,” said Richard Titherington, chief investment officer for emerging markets and Asia-Pacific equities at JPMorgan Asset Management in Hong Kong. “I would expect that gap to widen.”
While a lot of the crackdown-motivated selling has hit China’s mainland stock markets, Hong Kong-listed shares succumbed last week, with the H-share measure sliding the most this year. The declines further exacerbated the split between the H-share index and the MSCI China, a gap that developed as China re-engineered its economy away from heavy industry toward higher-end technologies and the creation of a sustainable domestic consumer base.
Over the past five years, the differentiation in performance between the two indexes has been stark: The Hang Seng China Enterprises Index — which is almost 90 percent weighted toward financial, energy and industrial shares — has declined 2.2 percent, while the MSCI China is up 20 percent. Both gauges rallied Tuesday, with China said to be boosting scrutiny of stock traders ahead of a summit of international leaders in Beijing May 14-15.
Both indexes were introduced in the mid 1990s, but the 149-stock measure run by MSCI Inc. has diversified its membership beyond Hong Kong listings to include US-traded Chinese shares and is looking at ways to bring mainland-listed stocks into its ranks. Tech has the highest weighting in the MSCI China, at 35%.
The divergence is rattling Hang Seng Indexes Co., Hong Kong’s index compiler, which said in March that the H-share gauge had become less representative of China’s market. They proposed widening the scope of member companies, and are consulting market players ahead of an announcement expected in August, said Daniel Wong, head of research at Hang Seng Indexes.
Amid gains of more than 28
percent, consumer-discretionary shares and tech companies have driven the MSCI China’s 16 percent jump in 2017. Internet giant Tencent Holdings Ltd. — owner of the ubiquitous WeChat mobile messaging and payment app — rose to a record on May 2, just as last week’s decline in H shares and mainland stocks was getting under way.
Even if the H-share gauge opens up to more constituents, it will likely still exclude US-listed shares — a key driver for the MSCI China, said Philip Li, a Hong Kong-based senior fund manager at Value Partners Ltd. Alibaba Group Holding Ltd. is a big gainer that is included in the MSCI China but not in the H-share gauge because it is US listed.