(Bloomberg) -- The stocks of Chinese companies traded in Hong Kong are set for a bout of catch-up after having underperformed their counterparts on mainland exchanges by an unusually large amount so far this year, according to Goldman Sachs Group Inc (NYSE:GS).
The bank’s analysis highlighted some key conditions currently in place that should reverse the trend seen so far in 2019:
- Investors already moved to lift ownership of Shanghai shares, in part reflecting the strong gains this year, while positioning remains light in Hong Kong
- History shows that Chinese stocks that trade in Hong Kong -- H-shares -- do well if domestically listed shares -- A-shares -- trade in a range, as Goldman expects them to
- Cuts in earnings estimates have passed the peak and credit conditions point to further recovery in China’s economy. And H shares tend to react “more forcefully” to macro and micro fundamentals than A shares, according to the bank
“The catch-up case appears in place,” Goldman strategists including Kinger Lau wrote in an April 28 note. The thesis is being put to the test after Chinese shares last week fell more than equities in Hong Kong.
Shares on Hong Kong’s Hang Seng China Enterprises Index are up 14 percent this year, well off the Shanghai Shenzhen CSI 300 Index’s 29 percent advance. The last time that H-share underperformed A-shares by more than 15 percentage points was in 2015, the Goldman strategists calculated.
“Empirically, valuation gaps at such high levels usually precede decent H-share outperformance over their A-share tickers in the ensuing months,” they wrote.
Investor positioning also suggests further gains in Hong Kong, according to the analysis. Mutual funds are underweight offshore equities by a record 316 basis points, while valuations on the Hong Kong China gauge remain at, or slightly below, average for this stage in the cycle, they wrote. In addition, southbound flows have strengthened recently after a muted first quarter, Goldman said.
A-shares are arguably more sensitive than H-shares to perceptions of policy and liquidity, according to Goldman. A-shares have suffered lately thanks in part to worries that China’s leadership isn’t prepared to expand its stimulus efforts. An April 19 statement from a meeting of the Politburo indicated the economy is stable enough that extended policy support won’t be necessary. Officials later tried to reassure investors their “prudent” stance hadn’t changed.
Insurers, brokerages and consumer-staples companies are best-positioned for the potential catch-up rally, the Goldman strategist wrote, citing valuation gaps revisions to earnings-per-share estimates. The strategists recommended stocks including China Pacific Insurance Group Co., Citic Securities Co. and Tsingtao Brewery Co.