Hong Kong’s rally isn’t done yet

Lee Shau Kee, the billionaire chairman of Henderson Land Development Co., has said he will donate HK$1 billion ($128 million) to charity each year that the Hang Seng Index stays above 30,000, and double that if it reaches 40,000.
The 89-year-old should be prepared to hand out the cash.
Sure, Hong Kong’s benchmark gauge closed above 30,000 on only one day last week, with the market being dragged down by the worst stock rout in mainland China since June 2016.
But there are reasons to be optimistic, not least because Goldman Sachs Group Inc. sees the index ending next year at 32,000.
Just to get this out of the way: I’m not a blind China bull. Last week, I warned that China’s Beautiful 50, a group of large-cap cash cows such as Kweichow Moutai Co. and Ping An Insurance (Group) Co., were rallying too quickly and that the government’s move to reduce moral hazard in the wealth management industry could lead to a bond market rout. Both predictions came true on Thursday.
But pure market mechanics are on Hong Kong’s side. It’s become the end destination of a liquidity train. Through the so-called stock connect programs with Shanghai and Shenzhen, mainland investors have traded almost HK$1.7 trillion in the city in 2017, more than the previous two years combined, with accumulated inflows reaching HK$251 billion in the first 10 months — up 24 percent year-on-year.
Southbound flows through the exchange links represented 14 percent of Hong Kong’s monthly average trading volume last month, up from just 3 percent at the start of the year.
This is the third mainland-liquidity-driven rally Hong Kong has seen. On May 11, 2007, China allowed local financial firms to invest in overseas stocks through the qualified domestic institutional investor, or QDII, program. The Hang Seng Index reached an all-time high of 31,638 in October of that year.
The second episode was in late March 2015, when China said mutual funds could participate in the stock connect. The benchmark index rose 4,000 points in a month to its highest since the 2007 record. In October 2007, the Hang Seng Index traded 42 percent above its 200-day moving average at the peak. During the 2015 bull run, the premium reached 17 percent. As of Friday, the gauge was about 14 percent higher than the 200-day average. If the history of these technical indicators is any guide, we haven’t seen the peak yet. In terms of market breadth, the index remains healthy, with 80% of its component stocks trading above their 200-day moving average. In other words, it isn’t just Tencent Holdings Ltd. that’s pulling the market higher.
Apart from Tencent, mainland investors have been buying shares of big banks, whose valuations still aren’t demanding. Shares of companies with dual listings in Shanghai and Hong Kong are 30 percent cheaper in the southern city.
As for market darling Tencent, its run may not be over — even after a 121 percent surge that lifted the Chinese internet giant to a $500 billion market cap and saw it surpass Facebook Inc. Morgan Stanley raised its price target on Tencent on Friday, forecasting the shares will rally to HK$480, or another 16 percent.
To be sure, Hong Kong will have to tolerate plenty more ups and downs before the peak is reached, as more hot money arrives in search of quick profits. CLSA Ltd.’s Alexious Lee estimates that the proportion of trading via the stock connect by mutual funds has declined to 14.8 percent this year, from 17.4 percent in 2016. In other words, more individual investors are now buying through the trading links. Their presence means higher volatility, especially as we approach the year-end holiday season.

— Bloomberg