Today's comment is by Mike Burnick, our Senior Editor and Global Markets Analyst and editor of the new signature investment research service, Global Market Investor.
Dear A-Letter Reader,
China's monetary authorities took another big step toward liberalizing financial markets last week. It seems they're finally getting serious about reining in excessive stock market speculation in the mainland's overheated stock markets.
Interestingly enough this important move by the government didn't merit much mention in the western press. This story wasn't covered much better by the local beat either - which is exactly the way I like it.
I see this initiative as a vitally important step toward leveling the investment landscape in China. From a money-making perspective, this should be a key catalyst for Hong Kong shares, which have quite a bit of catching up to do with their mainland cousins. Let me give you the whole story that you won't get on CNBC.
First, the BIG news:
On Friday afternoon - Beijing time - after the markets had closed for the week, the China Banking Regulatory Commission announced that mainland investors would be allowed to purchase overseas equities for the first time.
I have been expecting - in fact hoping for - a development like this for some time. And apparently so have many other investors, who pushed the Hang Seng Index of Hong Kong-listed shares to a new record high the very next trading day, accompanied by unprecedented volume.
Shanghai & Shenzhen: No Longer the Only Games in Town
Make no mistake. This is a sea change in the way China will invest going forward.
According to Beijing's newly modified qualified domestic institutional investors program (QDII), big Chinese commercial banks are now free to invest as much as 50% of funds in overseas stock markets. Banks can finally invest outside the Shanghai and Shenzhen exchanges, which were previously the only game in town.
We are talking billions of dollars in investment capital in search of higher returns than offered by Chinese savings accounts, which yield less than the "official" inflation rate.
Of course, there's a wide world of investment opportunities out there, as I'm always telling you. But the average Chinese investor knows that the best game in town is still China itself. After all, how can an investor go wrong in an economy expanding 11% last quarter, where reported corporate profits are surging 80% year over year?
The investment capital can go anywhere overseas but I expect that the majority of it won't go very far. Hong Kong seems like the most logical destination.
HK Listed Shares are Sure to Get a Boost
Here's the deal: Many of mainland China's biggest blue-chip companies also have shares listed on the Hong Kong stock exchange. This arrangement was originally necessary for these companies to raise much needed capital. This was way back in the dark days before the Shanghai Stock Exchange was surging to triple-digit gains.
But due to draconian capital controls imposed by the government, only the wealthiest retail investors, along with the major banks and brokerage houses, had any chance of investing even a token amount overseas. By Beijing's definition, "overseas" also includes Hong Kong. And individual investors were completely forbidden from taking their investment assets anywhere else.
But now those restrictions have been lifted by half . And if you know just where to invest, you can position your portfolio in front of potentially trillions of dollars in investment capital that may soon begin flowing to Hong Kong in search of much better stock market values, and higher returns.
Hong Kong's H-shares a Screaming Bargain Compared to Shanghai
With the government's long history of strict capital controls, China's stock markets developed a two-tiered trading system. Share prices of some companies in Shanghai are quoted at prices 50% higher, and in some cases twice the price , of the very same company's shares listed in Hong Kong.
The reason for this disconnect is simple. Chinese mainland investors had no choice because of Beijing's capital controls. They could either buy shares of China's big domestic energy firm Sinopec - on the Shanghai exchange - at a 60% premium to the share price in Hong Kong . Or Chinese investors were always welcome to keep their money in a bank CD earning 3%. Either way, they lost.
But now, thanks to China's partial relaxation of the rules, Sinopec and many other Chinese mainland stocks just became a whole lot more attractive to purchase ... at least in Hong Kong.
You could see this fact clearly demonstrated in yesterday's market action.
Monday was the first opportunity investors had to react to the new rules announced late Friday. The Hang Seng China Enterprises Index (HSCEI) of 42 mainland Chinese firms, which also have shares listed in Hong Kong, surged more than 5.5% higher to a new record.
The Shanghai exchange was up about 0.8% on the day. That's a remarkably restrained performance for this year's hottest global stock index, which is already up more than 50% in 2007.
The HSCEI by contrast was basically flat this year - that is until yesterday's big surge. And I believe that Monday's big rally in Hong Kong shares was just the opening act!
Beijing's rule changes will profoundly affect the way hundreds of millions of Chinese invest their growing wealth going forward. And it creates a huge opportunity for you to profit by jumping in ahead of the curve, before this tidal wave of investment cash flows into financial markets.
MIKE BURNICK, Senior Editor & Global Markets Analyst
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