The flag (R) of the Hong Kong Exchanges and Clearing Limited (HKEX) is hoisted next to China's flag (C) in Hong Kong on August 16, 2016.
China's central government has approved plans to link trading between the Shenzhen stock exchange and the Hong Kong market, it said on August 16, paving the way for the long-awaited reform. / AFP PHOTO / Anthony WALLACEANTHONY WALLACE/AFP/Getty Images
© AFP

Judging investors’ mood towards China can be a tricky exercise. If you assess the reaction to the landmark announcement of a direct trading link between exchanges in Shenzhen and Hong Kong that will for the first time allow international investors to bet on Chinese technology groups, it looks bearish. A week on from the news, Shenzhen and Shanghai markets are lower, while analysts’ views on Hong Kong Exchanges — which would be the biggest direct beneficiary of a planned link — are their gloomiest in more than three years.

Yet follow the money trail and the mood is more nuanced. Chinese stocks listed in Hong Kong have gained more than 10 per cent in the past two months, putting them among the top 10 performers in the world. It has also been one of their best showings since the rally and subsequent rout in mainland China last year. Hong Kong indices mostly reflect international money, and some of it seems ready to warm to China again.

There is some explanation for the contrasting pictures. The opportunity presented by the trading link with Shenzhen isn’t quite the same as betting on China via the state-backed companies that dominate the stocks available in Hong Kong. And, frankly, there should have been more excitement about the creation of the world’s second-largest pool of equity capital by linking China’s three trading hubs for the first time.

Some of the lacklustre response to the Shenzhen news can be put down to scepticism that anything in China billed as a milestone will actually be one — or provide moneymaking opportunities.

There has also been an effort among commentators to avoid a repeat of the enthusiasm that greeted the Shanghai version of the trading link that launched in November 2014. Then, bankers predicted investors would reach the scheme’s overall trading limits in days as brokerages’ research teams scrambled to hire the best analysts of A-shares — or those traded in mainland China — reportedly doubling their price in the process.

In fact, mainlanders have used only about four-fifths of their overall quota and international investors heading into stocks in Shanghai just two-fifths.

In spite of all this, there are reasons to be excited about Shenzhen. Generating interest in Hong Kong and Shanghai shares can be tough. Both are dominated by Chinese financials, state-owned enterprises and in Hong Kong, too, tycoon-controlled empires. None of these are the stuff of investor dreams. More than one analyst admits Tencent, a rival to New York-listed Alibaba, is about the only Hong Kong large-cap company investors consistently ask about.

Hong Kong’s recent rally is a sign that a sliver of optimism about China is returning. Since Chinese shares tend to trade outside the mainland at lower valuations, there is an element of arbitrage in the gains. But even that suggests fewer investors worrying the mainland Chinese economy is about to implode as feared during January’s turmoil.

Shenzhen stocks far more closely represent “new China” — the online, 4G-enabled companies tapping into consumer growth that investors are interested in. Three behemoths outside Shenzhen — Alibaba, Tencent and China Mobile — account for more than half of so-called New China’s representation in the MSCI China index, according to Francois Perrin, a portfolio manager at East Capital.

Until mainland shares are included in MSCI indices that dominance will not change. However, opening Shenzhen to direct trading for foreign investors will make it easier for those who don’t track the index so closely to go off-piste and find other ways to bet on China. They will have to rootle about: the average market cap in the southern city is half that of Shanghai, meaning there are far more mid- and small-caps to consider. Both markets are dominated by retail investors, whose preference for fast-moving smaller stocks has helped push valuations higher in Shenzhen.

Taking a wait-and-see approach to a pricey rollercoaster market is understandable. And any view less than outright bearish on China still requires guts in the current environment. But it isn’t every day a market this large opens up. The link is scheduled to be running by the end of the year. Now’s the time to look closely at what’s on offer.

jennifer.hughes@ft.com

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