Natixis: Shenzhen link won’t divert money from elsewhere yet

The rest of Asia need not worry about China absorbing big chunks of capital once the Shenzhen-Hong Kong Stock Connect goes live, argues French bank Natixis. High valuations in the tech-heavy Shenzhen index still make a compelling case for investment elsewhere, it said in a research note yesterday.

Southbound (China to Hong Kong) flows via the Shanghai trading link have been accelerating in the past few months and outstripping northbound volumes, as reported. That trend looks likely to continue under the Shenzhen Connect, which was approved on Tuesday and is expected to launch in December.

Whether the Shenzhen link will usher in a new era of inflows depends on a) how desperate foreign investors are to take exposure to mainland tech stocks and b) the steps China will take to instill confidence in its market management, noted the bank.

The startlingly rich valuations in Shenzhen are one potential deterrent. The first chart (see left) shows the price-to-earnings (P/E) ratio for Asia-Pacific stock indices, with Shenzhen the highest by a long way, and much higher than Shanghai’s.

While there are other sectors in the Shenzhen index, information technology is a key differentiator, but investors will have to pay for it, noted Natixis. The Standard and Poor’s 500 Information Technology Index has an average P/E ratio of 21 – half of that of Shenzhen’s.

“Shenzhen is still not cheap enough to warrant massive inflows, considering the risks,” added the bank, especially given that there are numerous Asian markets more attractively valued.

While southbound quota under the Shanghai Connect is almost used up, northbound quota is only half depleted (see second chart, right). This indicates there is more demand for better-valued assets in Hong Kong, said Natixis. “This is one of the reasons why the aggregate quota for the Shanghai-Hong Kong Index is now scrapped."

Of course, stock prices can be quickly revalued, said the research note; a more fundamental factor for future flows to China are capital-market reforms to reassure investors. And clear concerns remain on this front, as is shown by A-shares still being excluded from MSCI’s emerging-market indices.

Hence, concluded Natixis, “it is too early for the rest of Asia to be concerned about China absorbing capital due to its massive size”.