A China Play To Launch A Strong Q4

Since the Fed’s first rate cut back on Aug. 17, Hong Kong’s stock market has been going ballistic, breaking 27,000 for the first time last week. "H" shares — those of mainland Chinese companies listed in Hong Kong — have done even better, substantially outperforming local Hong Kong companies. And here’s why Hong Kong will continue to soar ahead and be a top performer during the Q4 rally.

First, the Hong Kong stock market is benefiting from the general rush to emerging-market stocks. The bet is that the Fed’s rate cut, as well as easier policy stances at the European Central Bank and the Bank of England, will boost already fast-growing, emerging-market economies. Emerging-market economies have been posting earnings growth even amid rising U.S. interest rates, so the Fed rate cut only turbo-charges this already fast-running engine of economic growth.

Second, the Hong Kong dollar’s peg to the U.S. dollar means that Hong Kong’s interest rates mirror that of the Federal Reserve. That means equity investors in Hong Kong get the benefit of a rate cut, while Hong Kong itself is enjoying brisk economic growth. The Hong Kong index is also heavily weighted towards interest rate-sensitive stocks, including financials, utilities and property — stocks that benefit disproportionately from an interest rate cut. And unlike elsewhere on the globe, Hong Kong banks have shown little if any sign of the effects of a credit crunch.

Finally, China-related markets — including Hong Kong — are all about liquidity. Stock markets in Hong Kong and Asia go giddy at the thought of the Chinese government investing some of its $1.4 trillion foreign exchange reserves abroad, and liberalizing the estimated $2 trillion in Chinese individual bank deposits. There is little doubt that any liberalization of Chinese mainlanders’ ability to invest abroad will result in a great wall of money ending up in Hong Kong.

That process has started. The China Investment Co. (CIC), the new fund set up to manage some of the country’s $1.4 trillion in foreign exchange reserves, is starting operations just this week. In addition, the Chinese government has introduced a scheme under which domestic institutional investors could invest in the overseas capital markets. Despite fits and starts, gradual liberalization seems inevitable. And Hong Kong is an unusually attractive destination for mainland money. Shanghai’s composite index may have 50 times trailing earnings, but Hong Kong’s price/earnings ratio of 17 is quite reasonable. The market won’t be in bubble territory for quite a while.

So buy the Hong Kong ETF (EWH) today at market and place your stop at $17.80. The market has had a big run up recently, so the market may pull back in the short term. But we’re betting that it will end the quarter much higher than it is today. If you are willing to accept additional risk for a chance at heightened returns, you may want to buy the Hong Kong ETF’s $20 December call options, EWHLD.X.

PORTFOLIO UPDATE

Otherwise, the Global Bull Market Alert portfolio is performing strongly across the board. All but one of our positions is profitable, and we have 50%-plus gains in two of our stocks — POSCO (up 87.47%) and Potash (up 59.03%) — and three of our options — CEDC (81.82%), Dryships (83.87%) and BHP Billiton (208.82%). I feel strongly enough about all of these positions that I am going to recommend that we hold off on taking profits on these for now.