Since February of this year, a narrative surrounding the revaluation of Chinese assets driven by DeepSeek has led to a remarkable surge in the Hang Seng IndexThis sudden spike has prompted a divergence between the performance of A-shares and H-sharesRecent data indicates that the cumulative increase in the Hong Kong stock market's Hang Seng Index has surpassed 15% since February, while the Shanghai Stock Exchange's Index has limped along with an increment of less than 4%. In this context, the AH share premium index continually drops, suggesting that, at present, A-shares may offer a superior cost-effectiveness advantage.

The decline of the AH premium has been ongoing since February, fueled by the diverging fortunes of A-shares and H-sharesOn February 24, the AH share premium index dipped to a remarkable low of 131.96 points during intraday trading, with a daily average around 134 points on February 25. This index was launched in July 2007 and reflects the average price differences between A-shares and H-shares of mainland companies that are listed in both markets, known as AH companiesWhen the index reads 100, it implies that, on average, A-shares are priced equivalently to H-sharesConversely, values above or below 100 reflect a premium or discount of A-shares relative to H-shares.

The AH premium index previously peaked in January 2008 at 208 points, which signifies that A-shares were enjoying a staggering 108% premium over their H-share counterpartsOn the contrary, April 2006 recorded a 15% discount for A-shares versus H-shares, marking a historical low for the indexNotably, after the close of 2014, the index has remained comfortably above the threshold of 100.

But why does a single company present a different price in both markets? According to E Fund Management, several factors contribute to this discrepancy, primarily market interest rates and investor preferencesThe characteristics of investors in the two markets further elaborate on this divergence

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A-share investors tend to have a shorter holding period and exhibit higher risk appetiteIn contrast, those in the Hong Kong market often hold stocks for longer durations and prioritize long-term safety margins of their investmentsSuch contrasting investor behaviors play a pivotal role in determining the valuation discrepancies for the same stocks listed in both markets.

Moreover, the reference market interest rates differ between the domestic A-share market and the Hong Kong H-share marketThe A-share market predominantly refers to the yield of Chinese government bonds as a benchmark for its market interest rateIn contrast, the Hong Kong dollar is pegged to the US dollar, maintaining a fixed exchange rate that directly ties the economy’s fiscal dynamics to that of the USThus, when Hong Kong market investors gauge stock valuations, they typically consider US treasury yields as their standard for market interest rates.

The variance between liquidity levels in these two markets also significantly influences the pricing discrepancies of AH sharesOverall, the A-share market exhibits markedly higher trading activity than its H-share counterpart, manifested in greater turnover rates and a more vibrant liquidity environmentSuch conditions foster what is termed a “liquidity premium,” where stocks in a more liquid market are valued at higher prices.

As the AH share premium index continues its downward trajectory, a growing sentiment among institutional investors suggests that A-shares currently offer better investment value compared to H-sharesGoldman Sachs, in a report published on February 23, underscored the potential for A-shares to rebound strongly over the coming three months due to valuation advantages and favorable policy expectations, predicting a 2% excess return.

Goldman Sachs further highlighted that historically, the three-month relative returns of A-shares versus H-shares typically oscillate within a ±10% range

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Any deviations beyond this range have high probabilities of reversingFor example, data indicates that when the return gap between A-shares and H-shares exceeds 15%, a significant 95% likelihood exists for a subsequent reversal.

Analyzing the situation more closely, Goldman Sachs posited that small-cap stocks might outperform larger counterpartsIndices such as the STAR 50, ChiNext Index, and CSI 1000, which are made up of small-cap stocks, are expected to benefit from improving market sentiment, particularly because they have substantial exposure to AI-related sectors and a high proportion of retail investorsIn the realm of large-cap stocks, the newly introduced CSI 500 is anticipated to outperform the CSI 300 index due to its higher exposure to technology and innovation sectors.

Research from Everbright Securities reinforces the notion that ongoing policy support and capital inflows resulting from profit-enhancing effects will likely elevate market valuations furtherAt present, the valuation levels of the A-share market flirt with averages not seen since 2010. With proactive policies and the influx of new capital driven by previous gains, the prospects for A-market valuations stand poised for an upswing.

China International Capital Corporation has noted a shift in local institutional investors’ interests, now favoring equities over bonds, with a marked decline in appetite for dividend-focused stocksAmong global investors, the growing recognition of a revaluation in Chinese tech stocks is on the riseThe stabilization of the renminbi also serves as a significant indicator, suggesting a strong rebound in the currency as economic expectations between China and the United States begin to converge once more.

This dynamic interplay of valuation adjustments, investor behavior, and macroeconomic factors renders the Chinese equity market, particularly the A-shares, an area worth watching as it grapples with the realities of a changing landscape of investment affinity and economic policy.

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