The China Bubble Gets Bigger (2X)

January 30, 2008

The Hang Seng AH Premium Index hits a new all-time high, with prices in Mainland China double those in Hong Kong.

The Chinese stock market always has had a split personality. Lately, it has been getting even worse.

The Hang Seng China AH Premium Index, which measures the spread between the A-shares and H-shares of dual-listed companies domiciled in mainland China, is showing some real friskiness in early 2008.

Although it closed out January 2 at 180.37, by midmonth it had closed above 200 (at 201.11) for the first time. It hit a peak the next day to finish at 208.06 before dropping to a final 195.05 on January 17. There was a third close above 200 (206.78 on January 22), but as of January 29 it had fallen to just below the 180 mark.

Essentially, what this means is that the A-shares as a group are currently trading at a premium of about 80% over the H-shares and that at one point they were trading at a premium of more than 100%—or more than double the price of the H-shares.

For those unfamiliar with China's markets, A-shares are shares of stock in mainland companies that are listed on mainland exchanges and are largely available only to domestic investors. H-shares are shares of stock in mainland companies that are listed on the Hong Kong Stock Exchange; they are available mainly to nonmainland investors. Some mainland companies have both A-shares and H-shares trading, and Hang Seng Indexes created the Hang Seng China AH Premium Index to measure the spread between those shares.

While both H-shares and A-shares have risen dramatically with China's economic boom, the A-shares market has risen more sharply as domestic investors—with newfound investable wealth and extensive restrictions on foreign investment—have flooded the mainland exchanges with assets, driving up stock prices and creating an impressive bubble.

Perhaps the strangest thing is that, as the Hang Seng China AH Premium index was crossing over a milestone, both the Hang Seng AH (A) Index and the Hang Seng AH (H) Index were on losing streaks—it was just that the H-shares index were experiencing a steeper decline.

The day the premium index closed above 200, the A-shares index was down just 1.63% compared with a 2.82% decline for the H-shares index. The next day (January 16) the premium index closed above 208, but the A-shares index and the H-shares index fell 3.41% and 6.41%, respectively. When the premium index hit 206 a few days later, the A-shares index was down just 7.62% versus an 11.37% decline for the H-shares index.

So what's going on in Hong Kong?

Well, for one thing the local market is experiencing a great deal of what Hong Kong Monetary Authority Chief Executive Joseph Yam termed "turbulence." Concerns about the U.S. economy, particularly the subprime mortgage crisis, have repeatedly roiled markets, and matters have not been helped by rumors swirling around China's sidelined "through-train" program that would let mainland investors invest in Hong Kong's stock market.

Although the plan has been indefinitely postponed, rumors rose and then were quashed that China might soon put it into effect—which no doubt contributed to the chaos.

While mainland China is known for its volatility, as a closed market it likely reacts less to what is going on in foreign markets. Hong Kong, however, is a highly developed stock market with strong international ties. It seems likely it would have a stronger reaction to foreign events.


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