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Don’t forget the Hong Kong end of Stock Connect

Discuss the law of large numbers with statisticians and they mean using large samples to improve experiments. Analysts take the phrase to mean no company or economy can grow stratospherically forever. China watchers have another approach, forecasting eye-popping numbers for future foreign investment into Chinese financial markets. Expected long-term inflows via the Shenzhen-Hong Kong Stock Connect, launched on Monday, are no exception. But in the short term, the larger profits may come not from mainland investments but from the Hong Kong end of the system. 

Shenzhen is the largest market in the world still virtually untapped by international money: less than 2 per cent of its $3.4tn market capitalisation is thought to be held by foreigners. Extending the current Shanghai Connect to Shenzhen allows international investors for the first time to trade China’s new economy exchange without regulatory approval — and more than double the number of Connect stocks on offer. But the opportunity does not come cheap: the Shenzhen Composite trades on 32 times forecast earnings while Shanghai, home of state-owned groups, offers a multiple of 15 times. 

Hong Kong offers even lower valuations and an opportunity for mainlanders to hedge the renminbi’s slide — probably increasing its attraction as Beijing cracks down on fleeing capital. The blue-chip Hang Seng trades on 13 times forecast earnings while H shares — the Hong Kong traded units of dual-listed groups — offer a 30 per cent discount to their mainland counterparts. More than 100 small and mid-cap companies will be added to the list eligible for southbound trading — a one-third increase. That list includes mainland household names such as carmaker BYD and Li Ning, the sportswear brand. 

Mainlanders hold about 2 per cent of Hong Kong’s market cap and last year they almost doubled their percentage of trading volume to 9 per cent. HSBC estimates that if just 2 per cent of mainland deposits went into the Hong Kong market over the next five years, it would mean inflows of $29bn a year. The Connect is not a capital flight channel since it is a loop and users can only cash out in their starting currency. But after Beijing’s moves last week to close outflow channels, parking money in US dollar-pegged Hong Kong assets should look increasingly attractive.

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