An investor looks at stock information at a securities brokerage house in Nanjing, East China's Jiangsu province, Nov 28, 2016. [Photo/IC]

Small cap stocks are expected to benefit most, but rise is limited by global uncertainties

Both the Chinese mainland and the Hong Kong stock markets saw a rally on Monday after the China Securities Regulatory Commission (CSRC) confirmed that the Shenzhen-Hong Kong Stock Connect will be launched next Monday, but global market uncertainties still held down performance, according to experts.

On Monday, the Shanghai Composite Index rose 15.05 points, 0.46 percent, to 3,277 and the Shenzhen Component Index increased 32.34, 0.29 percent, to 11,068.87. Hong Kong's Heng Seng Composite Index went up 107.12, 0.47, percent to 22,830.57 and the small-cap based Heng Seng China Enterprise Index jumped 85.31, 0.87 percent, to 9,875.54.

Hannah Li Wai-han, a strategist at UOB Kay Hian (Hong Kong) Ltd, said that since the news of the second stock connect was digested by the market four months ago, the increase in markets today is within expectation, with global uncertainties suppressing the overall rise. She predicts the Hong Kong benchmark index will fluctuate around 24,000, in the best scenario. Small cap stocks in healthcare, new energy and internet sectors in the Hong Kong market should especially benefit from the second stock connect.

According to Jerry Xie Weiyu, senior strategist at SWS Research Co Ltd, the impact of the stock connect in the medium and long term is definitely profound. He affirms the asset allocation of large insurance institutions and publicly-offered funds in the mainland will support the Hong Kong market due to southbound fund flows. And, due to the relatively low valuation of the Hong Kong market, it will finally outperform the Chinese mainland equity markets next year.

However, Xie elaborated, in the short run northbound fund flows will exceed the southbound after the second stock connect officially opens up, because the marginal increment in a relatively closed market like A-shares will initially be larger than in an open market. The newly included medium and small-cap stocks in Shenzhen are attractive and are different from the large company stocks made available earlier by the Shanghai-Hong Kong stock connect.

According to Steven Sun, an equity strategist at HSBC Holdings Plc, northbound fund flows could reach $500 billion in five to ten years. So, the connect significantly strengthens the case for the MSCI index to include A-shares. With the 100 percent inclusion of A-shares in the MSCI Index, which is likely to happen in the next five to ten years, it is estimated that foreign fund inflows could reach $500 billion, around 3.5 trillion yuan, which is roughly 10 percent of the existing A-share free float.

Jensen Liang Jinxin, assistant analyst at the overseas research department of SWS Research Co Ltd, said the impact of the second stock connect on the Hong Kong stock market and the revenue of brokerages is limited in the short term, but, in the medium and long term, it will improve the quality and liquidity of small-cap stocks, as Chinese mainland investors favor small-caps.