All-In in Hong Kong

08/04/2009 1:00 pm EST

Focus: ETFS

Jim Trippon

Editor-in-Chief, China Stock Digest

James Trippon, executive editor of China Stock Digest, says Hong Kong stocks have lagged their high-flying mainland brethren, and now could begin to catch up.

The indications in New York, Hong Kong, and Shanghai [are] that we’re in the midst of an unprecedented psychological shift from fear of a global cataclysm to an assumption of survival. And in the end, it’s psychology that rules the market, because most people are motivated by gut instinct rather than by actual numbers.

I see the US economy declining while stock market conditions continue to improve in anticipation of recovery. Therefore, I predict there’s at least a 12- to-16-month rally on the way! The Shanghai market may be approaching bubble status, but Hong Kong stocks and Chinese American Depositary Receipts (ADRs) traded in New York have a long way to grow.

How big a rally am I expecting? My internal modeling indicates that the market indices are likely to rise between 20% and 35% over the time [period] mentioned above. Many of the signals I have reviewed indicate probable explosive up side patterns in which many stocks could double or even triple during this cycle.

Our biggest buy was the iShares MSCI Hong Kong Index Fund (NYSEArca: EWH). This exchange traded fund provides many of the benefits usually attributed to a mutual fund without the high expense ratio that some funds charge.

Hong Kong has become severely oversold as China’s mainland leads Asia out of the recession. Hong Kong stands to be a major beneficiary. Until recently the Hang Seng Index was languishing at levels not seen since the SARS flu scare in 2003. [EWH gives investors] access to the Hong Kong exchange’s blue-chip equities, stocks which are usually inaccessible to foreign investors.

EWH uses a “passive” or indexing investment approach, which attempts to approximate the investment performance of its benchmark index compiled by Morgan Stanley Capital International (MSCI). The EWH Fund does not match exactly the high-flying and well-known Hang Seng Index.

In tracking the MSCI Index. EWH is based on a portfolio of large-cap, value-oriented equities. Not surprisingly, given the nature of Hong Kong, the EWH fund has the largest portion of its holdings (more than 60%—Editor) in financial stocks.

With more than 40 holdings, EWH has relatively low exposure to large-cap Chinese mainland equities (where many large state-owned enterprises have been underperforming lately).

Nevertheless, EWH is likely benefiting from the flow of funds from mainland China seeking cheaper stocks compared to the very high-priced shares offered on the Shanghai and Shenzhen Exchanges. As long as prices for equities on the mainland remain in the stratosphere, we anticipate ongoing buying pressure for the shares represented by EWH.

EWH is added to our buy list with a buy-up-to price of $15 a share. The stock is already topping this buy limit (it closed below $16 Monday—Editor), but may fluctuate, providing new buying opportunities at the suggested price.

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