Hang Seng Index Losing 10% Shows China Risks to Banks

By Jonathan Burgos

Jan. 26 (Bloomberg) -- The 10 percent drop in Hong Kong equities since November underscores the increasing threat to valuations as China curbs growth and the U.S. proposes limits on the banking industry.

Financial firms and property developers led the Hang Seng Index down from a peak on Nov. 16 after China mandated higher loan reserves and U.S. President Barack Obama sought to bar banks from proprietary trading. The Hang Seng fell ten of the last 11 days into the first so-called correction among developed markets in 2010, after a 128 percent gain in lenders last year spurred the biggest advance in a decade. It closed 2.4 percent lower at 20,109.33 in Hong Kong today.

Hong Kong is retreating more than twice as fast as other industrialized nations and may rebound just as quickly, according to Henrik Degrer, a fund manager at Svenska Handelsbanken in Stockholm, which oversees $36 billion. Financial companies account for a bigger proportion of equity value than in any developed country except Greece, exaggerating the Hang Seng’s swings and giving it the worst drop among the world’s 10 largest markets this year, data compiled by Bloomberg and MSCI show.

“It’s quite a volatile market, so 10 percent there does not mean much,” Degrer said. “The problems that you have in China spill over there more than other markets, and the financial sector exposure is quite important. If you take a long view, we are still bullish on emerging-markets growth, but in terms of timing you should be more cautious about it.”

Annual Gain

The Hong Kong gauge slid 0.6 percent yesterday on concern Chinese companies may need more capital after Bank of China Ltd. announced plans to raise 40 billion yuan ($5.86 billion) selling convertible bonds. The 5.8 percent decline in 2010 through yesterday compares with a 1.7 percent retreat in the MSCI World Index, data compiled by Bloomberg show.

The decrease follows a 52 percent gain in the Hang Seng last year, the biggest since 1999, as record new loans in China and a $586 billion stimulus package helped the nation ride out the global recession. The return was almost double the MSCI World’s 27 percent climb.

China is starting to take steps to cool the economy, which grew in the fourth quarter at the fastest pace since 2007. Gross domestic product expanded 10.7 percent while consumer prices rose a higher-than-estimated 1.9 percent in December from a year earlier, according to government data on Jan. 21.

Bank Reserves

Chinese banks have begun restricting new loans, responding to a push by regulators to contain credit, people familiar with the matter said. The central bank raised the proportion of deposits banks must set aside as reserves on Jan. 12, triggering a 3.1 percent decline for the Shanghai Composite Index the following day, the gauge’s biggest loss this year.

Banking and property stocks have led the decline in the Hang Seng Index since Nov. 16 on concern monetary tightening in China will hurt demand for loans and real estate. Financial companies account for 60 percent of the MSCI Hong Kong Index, the second-heaviest weighting among developed markets.

Bank of China slumped 23 percent from the peak on Nov. 16 through yesterday. The lender is seeking shareholder approval to issue six-year convertible bonds, according to a filing to the Hong Kong stock exchange on Jan. 22. China Construction Bank Corp., the nation’s No. 2 lender, slumped 17 percent since peaking on Nov. 23 to yesterday.

Buying China

“Investors who have been bullish on China have been buying Chinese stocks in Hong Kong as well,” said Daphne Roth, the Singapore-based head of Asian equity research at ABN Amro Private Banking, which oversees about $21 billion in the region. “Anything that has to do with China will come down.”

The declines have brought the average valuation for companies on the Hang Seng Index to 13.5 times estimated earnings, compared with 17.9 percent for the Shanghai Composite Index and 14.5 times for the MSCI World Index.

Hong Kong shares have not benefited from China’s approval of an overhaul of trading laws on Jan. 8 that will pave the way for short sales and stock index futures. The Hang Seng has fallen 5.8 percent since they were approved. For ABN Amro’s Roth, the declines are temporary and create opportunities to pick up stocks cheaply.

“The market is a little panicky because investors are not sure how much tightening China will implement,” she said. “China is trying to slow the acceleration in the economy, but I don’t think they will slam the brakes.”

To contact the reporter on this story: Jonathan Burgos in Singapore at jburgos4@bloomberg.net.