All news are good news

Being based in HK, what are currently happening in US is nothing new to us. Our property market collapsed after 1997 and it took almost 10 years to recover, we have SARS in 2003 that hurted our economy to an unprecedented extent. Both of these are not minor issues and experience tells us that it will take long time to recover.

However, when I look at the recent market reaction globally, people are ignoring all these facts.

Is the housing market really reached a bottom in US? Even if it is how quickly can it recover? In HK it was 10 years and not 1 or 2 years which Bernanke or Obama trying to pitch. Well, both of them are having probably the most difficult job in the world, if I were them I probably will do the same thing, the only solution to the subprime aftermath is to re-inflate the bubble.

I believe the Swine Flu impact may not be as serious as SARS, however, still I will not underestimate the risk. But most people's reaction in US is just life-as-usual.

I cannot really understand what's happening over the last few weeks when all news become good news. The only thing I learnt is that I shall never work against the market trend, I short the S&P 4 weeks ago and it proved to be a big mistake.

Having said that, how long can this all-news-are-good-news trend last? I still have reservation.

Q1 earning season is over, market interpretation to most of them is simply not-worst-than-the-worst means it's good and we see stock price jumped. Do we still look at PEG in valuation? what's the new 'G' in the ratio? Market simply ignore it.

CAF (the China A Share ETF that I followed very closely in the past) has reached an all time high 40% premium, while the historical high was about 20% since its launch in 2006. What does that tell us?




On the other hand the A-50 ETF (HKSE: 2823) premium is still trading at close to zero, given there are choices I will rather bet on A-50 if we believe the Chinese market is on a sustainable uptrend.

For more background on CAF and A-50, you can read a very old story I wrote 2 years ago, the link is here, though the story is old but the background doesn't change

Top 5 most influential stocks of the Hang Seng China AH Premium Index

The Hang Seng China AH Premium Index ("AH Premium Index") was officially started yesterday, real time indices are shown in the following table:

Real Time Index:


I’ve further analyzed the composition stocks and ranked the top 5 stocks with the biggest impact to the index. They are namely China Life, Sinopec, Bank of Comm, Ping An and Chalco. 5 of them already contributed around 20% premium, with the remaining 22 stocks altogether contribute another 10% giving a total premium of ~30%. (as of 9 July)

The full table is shown here.

A-share companies will begin reporting of their half year results this month, China Merchant Bank and ICBC had pre-announced their result last night with impressive 100% and 50% net profit growth respectively.

While H-share has gained very strong momentum over the past 2 weeks versus its A-share counterpart, whether it can keep the steam going will be very much dependent on the result announcements this month.

I would refine my Q3/Q4 strategy after seeing those results. In addition to catching the A-H convergence, I would start accumulating Olympics related stocks. I expect the heat will start in 2H till the event takes place in Aug 2008. In terms of sector I would look at media, hotel and sports related companies.

A Very Important Index Is Launched - Hang Seng China AH Premium Index

HSI Services Limited announced today the introduction of a series of Hang Seng China AH Indexes to help investors track the performance of those Chinese companies dual listed in China and Hong Kong.

The most significant one is the Hang Seng China AH Premium Index (“AH Premium Index”), an index measuring the weighted average premium (or discount)of A-share prices to H-share prices of the constituents. The index is designed in a way that the higher the index, the larger the premium of A shares over H shares, and vice versa. When A-share prices are at par with H-share prices on average, the index will be at 100.

Initially the index will have 27 large AH companies that have completed share reform as constituents.



As at 27 June 2007, the AH Premium Index closed at 146.73, meaning A shares are trading at an average premium of 46.73% above H shares.


The trend from Jan 06 to Jun 07 is shown in the following chart.

How to play this index?

No tradable derivative product is announced yet.

However, if you believe the A-H price gap will converge like I do and cannot wait, one possible way to play is to long a number of the 27 constituents. Regardless of the structure of derivative product, issuer has to hedge its position by long H and short A (if the index is trending down, ie, tightening of the A-H gap).

Instead of looking at the full list of 45 A-H dual listed stocks, we shall better focus on this shortened list of 27. I've updated the full list HERE with level of H-share discount sorted in order.

The index will be available and disseminated starting 9 July 2007.

Impact of A Share H Share and Red Chip Convergence to 3 ETF (CAF, FXI, A-50 Tracker)

"There's no reason why stocks listed in Shanghai cannot through some financial instruments be traded in Hong Kong. Similarly, I do not see why Hong Kong stocks cannot be co-listed in the Shanghai stock market through an arbitrage arrangement. We are discussing the mechanics of it."

Hong Kong SAR Chief Executive Mr. Donald Tsang said in an interview with Financial Times on 18 June.

Mr. Tsang is a very smart politician and he is especially good in gaining trusts from his bosses in Beijing, that’s why he could replace Mr. Tung Chee Hua, the past HKSAR Chief Executive in the middle of Mr. Tung’s tenure.

Mr. Tsang has also been very cautious in delivering messages from Beijing, he would not disclose any plan on change of Chinese policy unless it is 100% confirmed.

As such I would expect new policy leading to price convergence of dual listed shares in Hong Kong and China would be announced very soon.

The convergence has in fact already been started, we see a very strong upward momentum of Hong Kong listed Chinese companies since the Chinese market correction earlier this month. See the chart below comparing SH Composite with HSCEI (Hang Seng China Enterprises Index):

A Shares in Shanghai or Shenzhen are trading at premium to their H share counterparts listd in Hong Kong. As of 22 June H shares are discounted by 1.5% to 88%.

If you are holding any funds or ETF with A, H or Red Chip as underlying assets, you shall evaluate such convergence impact immediately.

Three such most common ETFs traded in US and HK are :

1. Morgan Stanley China A-Share Fund (CAF)
2. iShares FTSE/Xinhua China 25 Index (FXI)
3. iShares FTSE/Xinhua A50 China Tracker (2823.HK)

Following is my analysis of the potential impact to these 3 ETFs:

As the actual market reaction is impossible to predict, I’ve made the following assumptions in my analysis:

• Only constituents of each fund which are dual listed in HK and China are considered
• Uniform convergence of each dual listed stock
• The price gap between H and A share would not be completed closed, for illustration purpose I assumed H shares to go up by 70% (of the gap) and A shares to go down by 30%.
• Correlation of H share and Red Chip movement is ignored.
• Impact to "A only” shares (i.e., not dual listed as “A” and “H”) is ignored.
• Similarly impact to Red Chips is ignored.

In this TABLE I listed the H share discount for all 44 dual listed Chinese shares, composition break down for each of CAF, A-50 and FXI, and multiplied the discount and composition % to arrive at the potential impact. You can study the impact down to each stock in the table if you are interested.

In summary:

FXI has 39.55% of NAV invested in 10 H-Share companies (out of the 44 dual listed) giving a positive upside potential of 7.7%

CAF has 22.25% of NAV invested in 7 A-Share companies (out of the 44 dual listed) giving a potential downside of 1.8%

A-50 Tracker has 30.3% of NAV invested in 20 Chinese A-Shares Access Product (out of the 44 dual listed) giving a potential downside of 2.2%

Several Very Important Remarks :

1. My assumption of uniform price correction to all dual listed stocks is for simplicity only. I expect high quality H shares would experience a stronger re-valuation. So buying those shares with heaviest H discounts would not guarantee you profits.
2. As Red Chips will be returning home to list as A share in China too, we can anticipate similar re-valuation of those Red Chips, which is beneficial to FXI (or other funds or indices with strong Red Chip exposure) as it holds several high quality Red Chips such as China Mobile and CITIC Pacific.

What is my investment strategy to profit from this trend?

I have bought HSCEI index products, on top I have overweighed several selected H shares and Red chips as potential profit enhancers. How to pick those star companies? Let's discuss together in my Discussion Group !

A-Share Price Premium

A share and H share trade in two different markets (Shanghai/Shenzhen vs. Hong Kong) and there is no channel to arbitrage, adding to that the huge imbalance between supply and demand of high quality stocks in China has caused most A shares to trade at a premium over their H share counterparts.

The premium ranges from a few percents to several hundred percents when translated into HK$ equivalent.

For ease of reference, I would from time to time publish such table. Stay tuned !