Chinese Skeptics Deepen Biggest A-Share Discount in 3 Years

China's largest package of economic reforms since the 1990s is getting a bigger vote of confidence from foreign investors than from the nation's own citizens.

The benchmark index for Chinese stocks traded in Hong Kong has jumped 6.2 percent, more than twice as much as the Shanghai gauge, since policy makers led by President Xi Jinping pledged to ease China's one-child policy and liberalize interest rates on Nov. 15. That left mainland shares valued at a 5.8 percent discount, the most in three years, according to the Hang Seng China AH Premium Index.

In a year when Asia's benchmark stock index is up 10 percent and U.S. shares are rising the most in a decade, China's market is getting little respect. The Shanghai Composite is down 3.4 percent, trailing its Hong Kong counterpart by the most since 2010. Investors saddled with $698 billion of lost market value since 2010 are proving difficult to win back even as valuations in industries such as cement and transportation offer some of the biggest discounts ever versus shares traded outside the mainland.

"I am not in a hurry to buy stocks," said Chen Yifeng, a 35-year-old accountant at a state-owned company in Shanghai whose personal investments in the domestic equity market are valued at about 40,000 yuan ($6,566). "I need to see exactly how and when these changes mentioned in the meeting will be implemented. The confidence in the local market takes time to recover."

Relative Value

Perceptions of China, which contributed most to the global economy's rebound from the 2008 financial crisis, influence investment decisions around the world. Laurence D. Fink, the chief executive officer at BlackRock Inc., the largest money manager, said he's "less worried" about the outlook for markets in part because of China's reforms.

The Shanghai Composite added 0.6 percent to 2,206.61 at the close today, while the Hang Seng China Enterprises Index of mainland shares listed in Hong Kong rose 0.6 percent. The Hang Seng China AH Premium index dropped for a fifth day.

China's benchmark 10-year bond yield climbed to the highest level on record yesterday amid speculation borrowing costs will rise as the government loosens its grip on financial markets in the world's second-biggest economy. Volatility in the yuan touched a five-month high today.

Performance Gap

Policies detailed by the Communist Party on Nov. 15 include steps to expand farmers' land rights, let qualified private investors set up small-to-medium sized banks, accelerate the convertibility of the yuan and free-up interest rates. The document covers 60 measures designed to help elevate the role of markets while keeping the state in a "dominant" position.

The Hang Seng China index surged the most since December 2011 on Nov. 18, and narrowed its loss this year to 0.6 percent as of yesterday. The Shanghai Composite pared its 2013 decline to 3.4 percent, versus a 10 percent gain for the MSCI Asia Pacific Index.

The different performance is also evident in the specific stocks. Shanghai-traded shares of Anhui Conch Cement Co. closed yesterday at a 25 percent discount versus the company's Hong Kong-traded shares, compared with an average difference of 12 percent during the past five years. Toll-road operator Jiangsu Expressway Co. (177)'s mainland-listed equities trade at a 26 percent discount, within 1 percent of the biggest gap on record, data compiled by Bloomberg show.

Investment Caps

The spread between the two markets has existed historically because of investment limitations in China. The nation restricts access to its local equity markets through its qualified foreign institutional investor, or QFII, program. The government approved $48.5 billion of QFII quotas as of Oct. 30, up from $47.5 billion a month earlier, according to a statement posted on website of the State Administration of Foreign Exchange. That accounts for about 1.5 percent of China's $3.3 trillion market capitalization.

Foreign investors are less bearish because China's new policies will make long-term economic growth more sustainable, said Chen Li, a strategist at UBS AG in Shanghai. The rally will probably continue for the next two to three months as the government unveils further policy details while low valuations versus the rest of the world lure investors, said Chen, who favors insurers and makers of discretionary consumer goods.

'Quite Cheap'

The Shanghai Composite trades for 11 times reported earnings, a 21 percent discount versus the MSCI Asia Pacific Index, which is valued at 14 times profit, according to data compiled by Bloomberg. The Hang Seng China gauge has a multiple of 8.5, the data show.

"We still believe it's a good time to buy China in the long term," said Michael Chiu, an investment director for equities at HSBC Global Asset Management, which oversees about $419 billion. Chinese shares in Hong Kong and the mainland "are still quite cheap in valuation," he said.

Tang Jianhua, a 35-year-old engineer in Shanghai, says he's waiting to see how the government executes its reform plans before adding to his personal stock holdings.

The new policies "are all good but no one knows for sure about the implementation," said Tang. "It's not necessary to invest in a market where there's uncertainty and the general environment isn't that good."

Economy Risk

The Shanghai Composite climbed 21 percent in the six months after former President Hu helmed the Communist Party's policy meeting in October 2003, then erased all of its gains to trade about 4 percent lower by October 2004, according to data compiled by Bloomberg.

While China's leaders were focused on "rebalancing" the economy in 2003, many of the imbalances identified in that year's policy document worsened over the next 10 years, Stephen Green, head of Greater China research at Standard Chartered Plc in Hong Kong, wrote in a Sept. 2 research report.

Companies with the word Shanghai in their names added about $45 billion of market value in a month, more than Vietnam's entire stock market, after China's commerce ministry said on Aug. 22 that the government approved a free-trade zone in Shanghai.

Shanghai International Port Group Co., which led the rally in stocks linked to the free-trade zone, has tumbled 21 percent during the past two months as detailed plans for the area disappointed investors.

Short-Term Drag

"The prospects of Chinese equities are positive for the long-term, but near-term there are some execution risks with regard to implementing reforms," said Teresa Chow, a Hong Kong-based money manager who helps oversee about $1.5 billion at RBC Investment (Asia) Ltd. "Mainland investors seem to have more reasonable expectations."

China's plans to loosen the state's grip on credit and raw-materials costs, reduce lavish spending by government officials and improve environmental protection may turn into a short-term drag on economic growth, said Grace Tam, a Hong Kong-based global market strategist at JPMorgan Asset Management, which oversees about $1.5 trillion.

Local companies have postponed or scrapped 73.5 billion yuan of bond sales in November, up from 29.8 billion yuan last month, according to filings on the websites of Chinamoney, Chinabond and Shanghai Clearing House.

The nation's economy will probably expand 7.6 percent this year, according to the median of 53 estimates compiled by Bloomberg. That would be down from 7.7 percent in 2012 and the same pace as 1999, which was the weakest expansion since 1990.

"Foreign investors focus more on the long-term gain," said Tam. "The domestic players are more concerned about the short-term pain."