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Buy Hong Kong 43

CMC Markets

The US S&P 500 index hit a new all time high in trading overnight, reaching a level that is almost 20% higher than its pre-GFC high point. While there are good reasons for this performance, and valuations are not stretched, the drivers of this all time high should also benefit other markets. The Hong Kong 43 index is a notable laggard - and may have begun a significant catch up.

Economic recovery on top of record levels of central bank stimulus are no doubt key drivers of these record US share markets levels, but in a globally connected investment world these are a plus for many other countries as well. Investors nervous about high US share levels are no doubt eyeing other markets - and traders may see opportunities in relative value, or pairs trades - selling the US S&P 500 and buying other, potentially undervalued markets.

In my view, Hong Kong is an outstanding candidate. The most recent read on annual GDP growth at 3% (US 2.6%) is historically modest but relatively strong. Let's start with the big picture:

hang seng indexNote the series of higher lows since 2011. It's clear from the chart there is significant resistance between 23,000 and 25,000.  This gives a long term triangle. Despite recent rises, the Hong Kong 43 looks cheap on most valuation measures. the trailing P/E and 12 month forward P/E ratios are between 10 and 11 times, whereas the SP500 reads are 17.5 and 16 times).  The forward estimate for HK is broadly in line with the trailing - implying flat earnings growth, while the SP500 reads are implying double digit percentage growth - curious in light of HK's superior GDP growth. Additionally, there is dividend yield support. The HK43 is around 3.75% versus 2% for the S&P500.

The most common explanation for this discount on HK is its exposure to mainland China. The HK43 is 55% weighted to financial stocks - banks alone make up about 32% of the index capitalisation. Fears that lending in China will lead to an asset melt down, damaging exposed banks, have held the index back. However, there is very little evidence to back this theory, and the successful conclusion of negotiations  for OCBC to bid U$5 billion for Wing Hang bank points to higher confidence in the sector.

But its not just a valuation argument:

daily hsiThe index is describing a "W reversal", a double bottom formation (black arrows). Selling since December may be viewed as a corrective move of the 4,500 gain over the last six months of 2013 - the v-shaped reversals  both occur near the 61.8% retracement level.  This can be interpreted as a sign that the index will test the high around 24,000 - (although some analysts will wait for a move above the middle of the W around 23,000) and potentially move significantly higher.

Finally, here's the relative performance of the HK43 versus the US SP500 (green line):

index comparisonWhether investing or trading, this chart shows the potential for catch up in the Hong Kong share markets. Investotrs and traders must follow their own plans, but buying the HK43 is a prime candidate

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