In China's tale of two markets I'd follow Hong Kong's optimistic lead

11/29/2012 6:59 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

Something very curious is happening in China’s stock markets: They’re headed in different directions.

Hong Kong’s Hang Seng index is up 18.92% for 2012 as of November 29 and up 21.87% for the last 12 months.

The Shanghai Composite Index, on the other hand, is down 10.73% for 2012 as of November 29 and down 15.85% for the last 12 months. The Shenzhen Composite Index is down even harder with a 14.22% drop for 2012 through November 29 and a 25.21% plunge in the last 12 months.

Why the big difference?

China’s domestic investors, the ones who dominate the Shanghai and Shenzhen markets, seem to be locked into disappointment that Beijing hasn’t announced more dramatic stimulus measures. Domestic investors seem to have been counting on the recently completed change in national leadership to come with a festival of interest rate cuts and spending plans. What has been announced—more spending on railroads, for example—hasn’t been enough to get anyone excited. And so the Shanghai index remains mired below the psychologically important 2,000 level—it closed today at 1963.49. The Shanghai Composite hasn’t been this low since January 2009.

Hong Kong’s Hang Seng, on the other hand, has a big contingent of overseas investors. They apparently are paying more attention to economic indicators—such as the recent 20% jump in profits at China’s industrial companies in October. The index has been in a solid rally since September 6, climbing from 19,209 on that date to 21,923 on November 29 for a 14.1% gain.

My argument that it’s overseas optimism versus domestic pessimism is supported by the difference in performance in the A and B shares in Shanghai. The B shares, which are available to foreign investors, are down just 1.47% for 2012 to date versus the 10.77% decline in the A shares, which are limited to domestic investors.

I think right now that the Hong Kong market is the better indicator of a turn in China’s economic growth rate and improved prospects for growth and profits. It could take a long time, in contrast, for Shanghai’s domestic investors to get over their political funk.

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