The beginning of this week saw the launch of the stock-trading link –or Stock Connect –between Hong Kong and Shenzhen, a stock market on the Chinese mainland that features most of the country’s technology companies.
Back in November 2014, the Stock Connect between Hong Kong and Shanghai, the largest stock market on the mainland, became operational.
The Shenzhen-Hong Kong Stock Connect is important, first of all, because it marks the completion of a system that synchronizes trading in the three main securities markets in the country. It also helps Chinese investors access the securities markets in other parts of the world.
With more than US$3 trillion in total market capitalization (compared to US$16 trillion in New York), and robust trading (of which around half is by investors from outside), Hong Kong is an important capital market in the world.
The Chinese regulatory authorities must be commended for linking up the two mainland stock markets with a more open and mature market like Hong Kong. This helpsto reform the trading culture in the domestic markets so that it becomes closer to international rules and norms.
Further, the timing for setting up the stock-trading link is also important – for investors to evade some risk in currency exchange and also to avoid putting their all eggs in one basket, meaning the basket that contains the United States dollar and the US market.
At the moment, as ample signs suggest a rally in the US dollar (against all other major currencies) and a rally in American stocks (potentially benefiting from the tax cuts and hike in public infrastructure spending that US president-elect Donald Trump has promised), it may be hard for investors across the world to resist the temptation to convert their money into the greenback.
For some time now, China’s foreign exchange reserves and theyuan’s exchange rate against the US dollar have both been on the decline, because the Chinese currency has been used to buylarge volumes of overseas assets.
But the Chinese companies’ overseas buying spree cannot be sustainable, judging from the trend emerging in the US: Assets are becoming more expensive and the government is becoming restrictive.
If the USstock-market rally continues, liquidity will dry up a few months from now, and investors will be forced to give up some of their interests. Many Chinese investors are already talking about the need to deleverage before it is too late.
For them, foreign currencies, especially the US dollar, will become more precious. But the yuan will not become less significant simply because of its falling exchange rate against the US dollar in recent months, because it is still relatively stable against the dollar compared to other currencies.
Both its economic growth rate and currency stability can make China a useful hedge against the US, as Sun Mingchun, chairman and chief investment officer of Hong Kong-based Deepwater Capital, has pointed out.
In case of any instability in the US, either in the dollar or its stock market, investors may find China, especially its freer and more orderly market in Hong Kong, a worthy place to be in – so long as China can maintain a basic balance in its own economic transition.
At least in the foreseeable future, one can be almost certain that China’s three stock markets combined can be a more attractive market than many others.
With Hong Kong’s stock-trading connects with Shanghai and Shenzhen, Chinese investors will not have to exchange all their money into the US dollar at this time of uncertainty, but still chase value in a dollar-denominated market – which is part of Hong Kong’s uniqueness.
This is because, first, the Hong Kong dollar’s exchange rate is pegged to the US dollar and the Hong Kong stock market is a highly international one.
Second, the trading connects with the Chinese mainland do not require investors to exchange their money when they invest in Hong Kong.
Given time, the existing trading connects can easily expand their functionalities by facilitating trades in bonds and international investment funds. In turn, this will make the entire Chinese financial system more open and more agile in correcting its excesses.
