Notes From Hong Kong: More of the Same

by: L. Desjardins

The new tightening of the credit screw over the weekend came after market hours on Friday, with the announcement of new bank reserve requirements [in China], the fifth this year. But figures released Saturday assure that we are only at the beginning of the tightening phase. Inflation came in at 5.1%, while the industrial production, at 13.3% -- higher than estimates -- shows that the economy is still running on all cylinders despite repeated efforts by the government to somewhat slow it. The issue of credit tightening will remain with us not only for this week but for months to come, creating a serious headwind for the market.

INDICES 1 week 4 weeks YTD
Hang Seng Index -0.7% -4.4% 5.9%
HS China Enterprises -2.1% -7.3% -1.0%
FTSE/Xinhua A50 0.3% -4.4% -21.3%
Shanghai Composite -0.0% -4.8% -13.3%
CSI 300 0.1% -3.9% -11.2%
EWH -0.9% -3.8% 19.6%
FXI -2.2% -8.5% 0.7%
PGJ -1.5% -7.1% 8.0%

The fight against inflation is imperative for the Chinese Communist Party, and economists see Beijing using more forceful tools in the coming months, i.e. more interest rate hikes and letting the yuan appreciate more. Rising interest rates will pressure property stocks and financials in the weeks ahead, while a stronger yuan will benefit energy and material stocks. The bet for investors in 2011 will be on whether or not the Chinese government will be able to balance the fight against inflation with economic growth. That is what was on the mind of the Chinese leaders' minds at their Central Economic Work Conference over the weekend; I doubt they have the answers, given the usual platitudes in the press communique.

The three major CSI300 sectors moved up last week, allowing the index to close marginally higher from the previous week. Energy and material stocks were largely driven by commodity prices all week and got a boost on Friday from trade figures showing strong demand for commodities. Gains for industrials were registered also on Friday on the news of strong exports. Despite expectations of new restrictions on credit, financials managed to finished the week almost at the same level they closed on the previous week. The high-flying consumer staples stocks, notably the liquor producers, saw a lot of profit-taking for their worst weekly performance in two months.

SECTORS – CHINA 1 week 4 weeks YTD
CSI300 Energy 1.2% -9.0% -17.3%
CSI300 Materials 1.7% -7.4% -4.4%
CSI300 Industrials 1.3% 0.0% 1.5%
CSI300 Cons. Discretionary -1.8% -4.4% -5.7%
CSI300 Cons. Staples -2.7% 2.0% 17.5%
CSI300 Healthcare 0.1% -1.8% 27.1%
CSI300 Financials -0.2% -4.5% -25.0%
CSI300 Technology -1.8% -0.6% 21.2%
CSI300 Telecom 4.2% 3.3% -18.2%
CSI300 Utilities -0.9% -3.9% -18.3%
SECTORS – HONG KONG 1 week 4 weeks YTD
HS Financials -1.3% -5.4% 0.4%
HS Utilities -0.1% -2.2% 12.4%
HS Property -1.6% -8.0% 5.9%
HS Commerce & Industry 0.3% -2.4% 12.9%

The Hang Seng Index drifted downward on relatively low volume in the absence of market-driving news either from overseas or locally. The Commerce and Industry sub-sector managed to close up from the previous week, largely thanks to the strong performance of Tencent (OTCPK:TCEHY), up 6.1%, following its 2010 Tencent Games Carnival in Shanghai when it announced 22 new games. Credit tightening in China kept Chinese banks listed in Hong Kong under pressure, with the worst performer, Bank of China HK (OTCPK:BACHY), down 7.1 percent.

The poor performance of Chinese banks also weighed heavily on FXI, down 2.2% on the week. The worst performer among banks among the ETFs holding was CITIC Bank, down 6.0 percent. Worst among all constituents was Air China (OTCPK:AIRYY), off 12.1% week-on-week and down 13.5% since the beginning of December. Part of the drop is said to come from speculation that airlines will be negatively affected by the development of the high-speed rail network. The other side of the coin showed railway stocks doing very well last week, among them China Railway, up 7.4 percent. On Wednesday, the China Securities Journal reported that the government may invest as much as 4 trillion yuan on the nation’s railways as part of its five-year plan for the period ending 2015.

Note: The Shanghai Composite Index is the broadest base index encompassing all listed A and B shares listed in Shanghai. The CSI300 comprises the 300 largest A shares listed in Shanghai and Shenzhen. The Hang Seng China Enterprises Index covers 40 “H” shares issued by mainland companies listed in Hong Kong.The Hang Seng Index currently covers the 43 largest Hong Kong listed companies by capitalization. These HK listed companies include a number of mainland Chinese companies. EWH tracks the MSCI Hong Kong Index which is substantially different from the Hang Seng Index. FXI tracks the FTSE/Xinhua 25 Index which includes the 25 largest mainland companies listed in Hong Kong.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: I am long CSI300 in Hong Kong.