Investing

How Index Funds Exacerbate The Disconnect Between Economic & Stock Performance

Published

May 3, 2023

Key News

Asian equities were lower overnight with Mainland China still on holiday until tomorrow.

Hong Kong was lower though not nearly as much as US-listed China ADRs yesterday. Yesterday’s bear raid took advantage of Asian investors being on vacation as there was no news except some clickbait nonsense. If you get the sense I’m annoyed you are correct! Shorts/sellers dictated yesterday’s narrative as the geopolitical overhang kept buyers on the sidelines. Yes, US stocks were awful yesterday as the US bank crisis spreads in advance of the Fed’s interest rate hike today and investors waking up to the debt ceiling issue.

Starbucks’ Q2 financial results and Yum China’s Q1 2023 financial results are yet another example of China’s economic rebound that will incrementally improve across 2023. Holiday travel numbers look very strong as Mainland media noted that the number of trips increased 70% year over year and 119% of 2019’s level. China reopens tonight so hopefully we see buying volume pick up via Southbound Stock Connect though I assume most folks took the whole week off. Hong Kong short volume was 21% of Hong Kong’s main board turnover as Alibaba HK had 25% of turnover was short turnover. Hong Kong’s most heavily traded were Tencent -1.85% versus its OTC ADR -1.79%, Alibaba HK -2.37% versus the US ADR yesterday -3.12%, HSBC +0.34%, Meituan -0.91% versus its OTC ADR -3.02%, AIA -1.11%, Ping An -1.08%, JD.com HK -2.82% versus US ADR -3.55%, and Baidu HK -3.14% versus ADR -3.09%.

One issue is passive investors, ETFs, and index funds, no longer hold the US ADRs of Alibaba, JD.com, Baidu, and Li Auto as ownership has migrated to the Hong Kong share class due to index methodology as index providers always prefer a local share class versus an overseas share class. This migration likely explains an element of US-China ADR volatility. Hopefully, Mainland investors return from holiday tonight and push stocks higher. This also explains why we’ve advocated investors balance their offshore/HK-US ADR positions with Mainland China exposure as the latter is less susceptible to the “foreign investor freakout”. Remember, MSCI China is 80% offshore China and only 20% Mainland China. Easy “alpha” for managers to OW the Mainland IMO.

Caixin PMIs will be released overnight. Caixin’s survey, conducted by IHS Markit, focuses on small companies versus the “official” PMI conducted by the National Bureau of Statistics focuses on large companies. China’s economy and employment, like the US, are dominated by small businesses as State Owned Enterprises account for only 30% of GDP, 12% of employment, and 25% of tax revenue according to Goldman Sachs. Interesting right? The stats come from the growing body of research on the recent SOE reforms which are leading to the outperformance of the SOE stocks.

The Hang Seng and Hang Seng Tech fell -1.18% and -1.63% respectively on volume -12.21% from yesterday which is 55% of the 1-year average. 104 stocks advanced while 383 stocks declined. Main Board short turnover fell -1.37% from yesterday which is 68% of the 1-year average as 21% of turnover was short turnover. Value factors outperformed growth while large caps “outperformed” small caps. All sectors were negative except materials which gained +0.21% while energy fell -2.46%, utilities closed lower -2.2%, and real estate was down -1.89%. Food was the only positive sub-sector while media, food, and energy were the worst. Southbound Stock Connect was closed.

Shanghai, Shenzhen, and STAR Board were closed.

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