HONG KONG STOCKS SURGE TO SEVEN-YEAR HIGHS AND LOOK UNDERVALUED VERSUS SHANGHAI -- CHINA ISHARES BUILD ON LAST WEEK'S BULLISH BREAKOUT -- FOREIGN STOCKS CONTINUE TO ADVANCE WHILE THE U.S. IS STALLED
HONG KONG MARKET HITS SEVEN-YEAR HIGH... China has been the strongest stock market in the world over the last year. The launch of the Shanghai-Hong Kong Stock Connect last November allowed Chinese investors to buy Chinese stocks traded on both exchanges. It also opened up Chinese shares to foreign investors. Up until this week, however, most of the Chinese buying was in mainland stocks in Shanghai. Over the last year, Shanghai has risen more than 90% versus an 18% rise in Hong Kong. Chart 1 shows, however, that the stronger performance in Shanghai (black line) since last spring was needed to correct the weaker performance of mainland stocks relative to Hong Kong between 2010 and 2013. It now appears, however, than the pendulum has swung too far in favor of Shanghai. Chart 2 shows a relative strength ratio of Hong Kong relative to Shanghai falling to the lowest level since 2011. That suggests that the pendulum may start to move back in favor of the cheaper Hong Kong market. The view that Shanghai has become too expensive relative to Hong Kong may explain this week's strong buying of Hong Kong stocks. Last week's announcement that Chinese mutual funds would be able to buy Hong Kong stocks probably added to this week's upside breakout in Hong Kong. Hong Kong was also playing catch up on Wednesday after a three-day trading holiday. The blue line shows the Hong Kong Stock Index jumping 3.8% yesterday to a new seven-year high (in record trading). That puts both stock indexes at the highest level since 2008.
Chart 1
Chart 2
HONG KONG STOCKS CONTINUE SURGE... The weekly bars in Chart 3 show the Hong Kong Hang Seng Stock Index breaking out to a new seven-year high yesterday. [The Shanghai Stock Index did that last month]. The rally continued again today with another 707 points (2.7%) tacked on to yesterday's explosive move. [Shanghai lost -37 points today]. Hong Kong iShares (EWH) are up more than 4% today (for a weekly gain of more than 8%). My Good Friday message showed China iShares (FXI) breaking out last week to a new seven-year high. The weekly bars in Chart 4 show the FXI rising another 10% this week to build on that breakout. [The FXI includes 50 of the largest Chinese stocks traded on the Hong Kong stock exchange]. Not surprisingly, Chinese stocks traded in the U.S. are among this week's biggest gainers. Chinese gains have also helped boost Emerging Market iShares (EEM) to a new seven-month high.
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Chart 3
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Chart 4
FOREIGN STOCKS CONTINUE TO OUTPACE THE U.S.... While the U.S. stock market continues to struggle in relatively trendless fashion, foreign stocks are gaining ground. At midday today, for example, stocks in Brazil, Canada, Europe, China, and Japan are seeing impressive gains while U.S. stocks are relatively flat. Chart 5 shows the Vanguard FTSE All-World ex- US ETF (VEU) trading at the highest level in seven months. The rising blue line is a relative strength "ratio" of the VEU divided by the S&P 500. The rising ratio shows stronger foreign performance (VEU up 7.9% in 2015 versus an SPX gain of 0.84%]. [The VEU includes foreign developed and emerging markets]. I suspect what's going on is a normal rotation between domestic and foreign stocks to get things back into balance. Chart 6 compares the VEU (blue line) to the S&P 500 (black bars) since both turned up together during 2012. They usually trend in the same direction because global stocks are positively correlated. The circle to the upper right, however, shows the U.S. diverging from foreign shares. Between last July and December, the SPX gained 5% while the VEU lost -9% (for a spread of 14% in favor of the U.S). Since January 1, however, the VEU has outpaced the SPX by an 8% to 1% margin (cutting the 10-month spread between the two in half). While foreign shares are rising, U.S. stocks aren't falling. They're just trading sideways. I suspect that will continue until foreign shares close most of the underperformance gap that started last July. Once that's done, the two should start rising together again. It's usually a good sign for the U.S. when foreign shares are also rising. But it's usually not healthy when the U.S. gets too far ahead, which it did in the middle of last year.
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Chart 5
