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`Huge valuation gap’ between HK and Shenzhen

Expect a spike in volatility when the Hong Kong-Shenzhen Stock Connect launches, said Li Chen, equity strategist at Credit Suisse.

Chen pointed out that the Shanghai-Hong Kong Stock Connect, launched in November 2014, provided southbund investors with access to large and mid-cap stocks.

With the forthcoming Shenzhen-Hong Kong linkage, expected in the second half, eligible stocks will likely include Hong Kong’s listed small caps. 

“The median price-to-earnings for Shenzhen small-cap stocks is currently at 82 times, while that for the Hang Seng’s small caps is only 15 times. There is a huge valuation gap,” he told FSA.

For southbound trading, the valuation gap suggests that Hong Kong small-cap stocks could gain support as “catch-up plays” to their Shenzhen counterparts, when the trading link programme is launched, he said.

The impact could be signifcant for the Hong Kong Stock Exchange because currently Chinese investors are not able to access Hong Kong small-cap stocks, he said.

For northbound trading, the linkage will have limited impact, as there are multiple ways for Hong Kong investors to access Shenzhen stocks, such as using a QFII quota or an RQFII quota.

“We know the quotas are abundant now and it’s easy to get them from brokers,” he said.

More volatility

Chinese retail investors have a preference for quality risk assets and therefore are more keen to buy small caps in Hong Kong than mid- or large caps, he said.

“This is likely to bring in more volatility.”

The involvement of mainland investors in the Hong Kong market will also increase.

Before the Shanghai-Hong Kong Stock Connect link was launched in November 2014, Chinese investors contributed only 10% to the trading volume in Hong Kong. After the programme launched, the contribution increased to 22% at the end of 2015, but southbound investors only went to the large-cap and mid-cap stocks, he added.

“When they can trade small caps in Hong Kong, which they like, the trading frequency could be increased, that means their contribution will likely increase.”

Chen said the house has four stock-screening rules to select what it believes are quality Hong Kong small-cap stocks. These include non-dual listed stocks, good accounting practices, low rating of default probability and a business model that is not “old economy”, such as banks, materials, energy and infrastructure.

He said that the Shenzhen-Hong Kong Stock Connect programme is expected to be launched during the second half of 2016.

“We are expecting the programme to be officially launched in August or September this year, after the two exchanges finish some experimental trials with IT infrastructure, possibly between mid-May and July,” he said.


From August – December 2015, a period of strong global volatility sparked by China, the Shenzhen market had a higher rate of return than the Shanghai or Hong Kong markets.

But it also had more wild swings. FE data shows during the specified period, Shenzhen volatility was 42.74 compared to Shanghai (33.55) and Hong Kong (21.31).



Part of the Mark Allen Group.