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Hong Kong Finishes the Week on a Positive Note, but for How Long?

By Dan Caplinger - Sep 25, 2015 at 1:50PM

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The Hang Seng remains exposed to China's woes .

Hong Kong skyline. Source: Wikipedia (Robster839).

Hong Kong's Hang Seng Index (HSIINDICES: ^HSI) has suffered considerably over the past several months, with the Asian stock market having lost more than a quarter of its value since the spring. For today at least, though, Hong Kong stocks managed a slight gain, with the Hang Seng closing up 90 points to finish the week at 21,186. Nevertheless, the longer-term question is whether Hong Kong can escape the brunt of China's economic slowdown or whether stock will continue to fall.

Friday's market action
The Hang Seng saw nearly three-quarters of its 50 component stocks rise on Friday, with strength in the real estate and financial sectors overcoming weakness in areas like technology and materials. Among the stocks that U.S. investors are most familiar with, oil giant CNOOC (CEO) posted a nearly 2% gain, while casino giant Sands China posted a better than 3% gain on hopes that the woes that the company has seen in its Macau operations will quickly improve. On the downside, China Mobile (CHL) fell more than half a percent, while tech leader Lenovo lost about three-quarters of a percent on the day.

From a broader perspective, Hong Kong's recent decline has reflected the sliding sentiment toward China. As growth slows on the mainland, the companies in Hong Kong that have profited from China's expansion face the prospect of seeing their core businesses suffer as a consequence.

Yet it's important not to conflate the Hang Seng and China's Shanghai Composite too much. Only nine of the stocks in the Hang Seng are also included in the Shanghai Composite, and although the two indexes have moved fairly closely in the recent past, longer-term trends have reflected the separate identities of the two markets. Moreover, differences in tradability have marked the two benchmarks, as Hong Kong's stocks are universally open to overseas investors. Recent reforms have opened up Shanghai's market to a much greater extent than in the past, but even now, some restrictions prevent the possibility of arbitrage across the markets, and that in turn supports different price action.

A turning point for Hong Kong
The major reason U.S. investors should pay attention to Hong Kong is that its performance relative to the Shanghai Composite will in large part define the future course of the stock market in China. With its institutional investor focus, Hong Kong tends to be more vulnerable to the changing tides of sentiment among brokerage companies and other financial firms but more resilient to changes in broader public opinion. Meanwhile, reports from Shanghai detail rising levels of participation among ordinary Chinese citizens, making that market potentially more susceptible to the irrational behavior of beginning investors.

Therefore, if Hong Kong holds up while China falls, it could suggest a public-driven bear market for Chinese stocks. If Hong Kong keeps falling, though, then it could point to institutions losing confidence in the region, and that has implications far beyond the Asia-Pacific region.

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