Beware the Hong Kong Effect

For the past few weeks, in a weekly column I email to various Asia sources and readers I have been reiterating to various degrees that short-sellers in Hong Kong should be aware of the sharp upswings in the Hang Seng and Shanghai Composite Index that are created by domestic buying. I want to share and expound on this argument for RealMoney, because I believe we are now about to see this effect take place.

Broadly, there are two sets of actors in Hong Kong right now, both with hefty sums of capital at stake: foreign and domestic money mangers. In terms of a general trading strategy, while the foreign investors seem to be selling into the bumps, domestic investors are buying into the dips.

It is of course true that regional hedge funds are shorting some of the big momentum stocks such as China Mobile (CHL - commentary - Cramer's Take) too, but only insofar as they are trying to make some speculative gains on the downside. This approach differs from the big asset-management firms in London, Europe -- and to some extent the U.S. -- which are actually selling on the belief that negative global growth indicators make Chinese betas (risk measures) a little high to bear right now.

This disparity in opinion has contributed to, if not outright caused, the kind of volatile motion sickness the Hang Seng has seen in recent weeks, as opposed to being sold off in one fell swoop.

Some of this is undoubtedly due to the foreign investment firms' investors, who are not inclined to stomach higher risk after being hit in subprime-spurred selloffs, and some of it is merely foreign investment managers adopting a more understandably conservative approach to the typical higher-risk premiums offered in markets there.

By being so cautious, however, foreign investors are in danger of either being caught out on the short side or missing what may well amount to some spectacular year-end gains. It is interesting to note all the fairly optimistic comments by analysts, strategists and money managers in Asia in the daily news reports, even when there are some quite stomach-churning declines. Also, there's a fair bit of domestic capital sitting on the sidelines right now that's ready to play the upside.

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At time of publication, Harrison had no positions in any of the stocks mentioned in this column.

Daniel M. Harrison is a business journalist specialising in European and emerging markets, in particular Asia. He has an MBA from BI, Norway and a blog at www.theglobalperspective.biz. He lives in New York.