China Stocks Exceed Expectations With Global Investors Buying 'Everything'

It is a golden week for China in more ways than one.

On Monday, mainland China stocks notched their best day since September 2008, leaping 8.5%.

The exchanges in Shanghai and Shenzhen are now shuttered through next Monday for the Golden Week holiday in honor of China’s national day on October 1. They resume trade on October 8.

Hong Kong was only closed on Tuesday, however, and is back in action with a bang on Wednesday. The benchmark Hang Seng index finished Wednesday up 6.2%, having at one point touched an advance of 7.3%. That caps a run of seven straight days of gains.

The Hong Kong market is now up 27.1% since the U.S. Federal Reserve cut rates on September 18. I indicated at the time that the Hong Kong market would be the big winner out of the U.S. rate cut, since Hong Kong’s pegged currency means it “imports” U.S. rates, whether local conditions require them or not.

I did not expect them to move so far, so fast. They were already moving higher when Beijing joined the party with the Chinese cabinet indicating the government would spend what’s necessary to shift the mainland economy out of its slump.

It is mainland-focused high-growth and consumer companies that are the biggest advancers, with the Hang Seng China Enterprises index of such companies up 7.1% for today. The Hang Seng Tech Index, where stimulus and lower rates should prompt the quickest rebound, up 8.5%.

I outlined both the series of monetary measures taken by the Chinese authorities last week, which weren’t enough to turn the tide, and then the cabinet’s surprising statement that it would spend what it takes to turn the economy and confidence around.

Only this second admission by China’s top leaders that there are “new situations and problems” facing the world’s second-largest economy, requiring “urgency” to solve them, has finally convinced the markets that the stimulus is for real.

Although we still don’t have specifics on what form that fiscal spending will take, it is a significant shift in mentality for the central government. Its efforts to deleverage the housing sector and take the hot air out of home prices have backfired, causing a total loss of faith in the property market and a tailspin in home values.

Chinese President Xi Jinping has pushed Marxist-Leninist ideals and often sounded highly skeptical of the private sector. He will presumably take a back seat as technocrats and the heads of China’s central bank and regulators lead the efforts to kickstart growth.

Wednesday's gains in Hong Kong are all the more surprising given that it’s a generally-down day elsewhere in Asia. Tokyo stocks ended the day down 1.4% in the form of the broad-market Topix, while the blue-chip heavy Nikkei 225 suffered a 2.2% stumble.

Japan imports all its energy so the heightened tensions in the Middle East and the resultant higher cost of oil will hit home, resulting in higher domestic production costs. Japanese exporters will also face elevated shipment costs to distribute their goods around the world.

Among mainland companies in Hong Kong, property developers are some of the fastest risers, but that’s after they were knocked to the ground.

Longfor Group LGFRY (HK:0960) soared 24.7% on Wednesday, with high-end rival China Overseas Land CAOVY (HK:0688) up 15.1%.

Grocery-delivery app Meituan MPNGY (HK:3690) rose 14.6% on Wednesday, with another extremely strong showing on the tech side for video-sharing app operator Bilibili BILI (HK:9626) up 21.9%.

Consumer stocks are also producing extremely solid gains. White-goods specialist Haier Smart Home HSHCY (HK:6690) has advanced 7.4% on Wednesday, smartphone maker Xiaomi (HK:1810) is up 6.7%, and video game developer/WeChat operator Tencent Holdings TCEHY (HK:0700) added 5.7%.

E-commerce giant JD.com JD (HK:9618), up 10.8%, outperformed rival Alibaba Group Holding BABA (HK:9988), up 4.6%. But that’s partly because Alibaba was one of the first stocks to run, and both platforms have notched outsize gains since that Fed rate cut, with JD up 77.5% since then, and BABA up 38.9%.

Many global investors such as hedge funds and mutual funds find themselves under-allocated to China stocks. They’re therefore driving some of the buying as they acquire the positions necessary to track their benchmarks.

Dan Rupp, who launched the Asia-focused, long-only manager Parkway Capital in January, believes there are still bargains to be found in the Hong Kong market. His was a lonely voice in January maintaining that China “remains both investible and drastically undervalued,” as he puts it.

But picking the right stocks at the right value is becoming important. 

“In our experience, deploying excess cash into smaller companies during a rally can be difficult,” Rupp said. “It often results in buying at suboptimal prices. Essentially, we have more good ideas than capital, so we’ve stayed nearly fully invested at these attractive valuations.”

The Hang Seng China Enterprises Index is still trading at less than nine-times estimated earnings for the next 12 months, Bloomberg data demonstrate. That’s less than half the multiples for the S&P 500.

I pointed back in May to David Tepper at Appaloosa Management, who at the time was selling down his holdings in the Magnificent Seven to buy beaten-down Chinese stocks. Alibaba is a favorite holding.

Tepper felt the Fed easing would lead China to cutting rates, as it has. But he too has been taken by surprise by Beijing bringing out the “big guns” on stimulus. He says he is buying “everything” China-related now that the central bank and market regulators are encouraging Chinese companies to buy back their own shares, and invest equity into the market.

There’s certainly life to China stocks, and a belief that “this time it’s for real.” Now the central authorities will need to deliver on their promises. There was a false dawn for Chinese stocks in February that rapidly gave way to gloom. Once the catch-up trades are completed, we’ll see where mainland stocks head once they resume trade next week. 

At the time of publication, McMillan had no positions in any securities mentioned.