China financials: champagne days

One definition of a bubble: "a surge in equity prices unwarranted by fundamentals". As Hong Kong's China Enterprise (HSCEI) and Hang Seng indices have jumped one-10th this month on a wave of mainland buying, many have suggested that the definition fits. Yet the rally in Hong Kong, a product of China's financial revolution, is overdue: the HSCEI still trades on single-digit multiples of 2016 earnings. Hong Kong "H" shares still trade at big discounts to mainland China listings. The buying could go on.

Since Tuesday, Hong Kong Exchanges and Clearing (now the world's largest listed stock exchange) has risen by a quarter. This makes sense, in part: two-thirds of the company's revenues come from trading volume-related fees. Goldman Sachs estimates a 5 per cent rise in cash equity turnover adds over 3 per cent to earnings per share. The past two days' trading alone have lifted year to date average trading value by 6 per cent. The stock is not cheap, priced at 35 times estimated 2016 earnings. The estimates may prove to be low. But at a multiple almost double the sector average, for similar earnings growth, rising estimates appear priced in.

Chinese brokerages have also done well, despite fines for breaking limits on retail margin lending in January. Citic securities, whose Hong Kong shares are up 50 per cent since the mid-January slip, now nudges the market capitalisation of Morgan Stanley. While Citic's 2016 consensus earnings multiple is nearly double that of the US broker, there may be cause for longer-term bullishness. Higher-margin derivatives markets, for instance, remain undeveloped in China. Citic has no exposure to index futures trading; competitors Haitong and Galaxy Securities garner less than 4 per cent of revenues from that business. Deregulation for stock options is under discussion; this would enable higher fees.

For foreign investors sceptical of paying up for Chinese brokers, banks may appeal. Banks make up a third of the H-share index, and shares in the top four including ICBC and Bank of China trade at about 5 times next year's earnings. All but Agricultural Bank of China are down year to date. With reason, perhaps. Non-performing loans are rising; a slowing economy is worrisome. But when a huge chunk of an index is bombed out, it hardly looks like a bubble.

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