“These sell-side analysts in Hong Kong have been saying that the A-share market is overvalued but they are just talking about the stocks they know. They say that because these stocks are overvalued the market is overvalued.”
This was the verdict of one Shanghai-based stock market professional on his counterparts in Hong Kong. If it is anything to go buy, there isn’t much love lost between the two groups. The market watcher – who is foreign – went on to question why these Hong Kong analysts still hold their jobs, given how they spent most of 2007 warning of declines in a domestic market that posted a full-year gain of 97% (although a disappointing final quarter stopped it being an even more successful 12 months).
Putting the mutual contempt aside, there is something in the original quote that is worth exploring. With foreign participation generally restricted by Qualified Foreign Institutional Investor (QFII) quotas, international investment banks have little reason to deploy armies of analysts to the task of researching mainland-listed stocks. Their focus is, understandably, on H-share/red chip/private sector firms that are listed in Hong Kong and therefore fair game for all foreign investors.
What all this means is that domestic stocks are under-analyzed and not subject to the financial scrutiny that is a standard characteristic of more developed markets. Even the analysts at domestic brokerages are not covering the whole board as they have made the bulk of their money trading established blue chips. Now these companies are overvalued (at least at present) because the demand for their shares far exceeds supply (hence Beijing’s policy of bringing strong, overseas-listed Chinese companies back to the domestic market).
The argument goes that if you apply proper analysis to the host of mid- to small-cap firms that are currently not so well known, you will uncover a host of new investment opportunities. In doing so, you will also expose more than your fair share of turkeys, but that’s life.
In fact, it could be argued that swift dose of Darwinism is exactly what the Chinese stock market requires. Cut the chaff, focus on quality and let the market make its own way. This will happen but only after the regulators have worked their way through a long list of reforms: non-tradable share reform, stock index futures and better corporate incentives and accountability, for example, are still waiting to be implemented.