(Bloomberg) -- Across the Chinese stock universe, something unusual is happening: international investors are getting the better deal.
For the first time in the past decade, foreigners are propelling the country’s bull-market run, with Chinese equities traded in Hong Kong and the U.S. racking up almost four times the gains of mainland shares since the market bottomed out 15 months ago. Despite a rally in recent days on suspected state intervention, Beijing’s de-risking drive has wounded onshore stocks, with local investors spooked by tighter regulation and the fallout from deleveraging.
Leave China and the rest of the world seems unfazed, with overseas buyers focusing instead on the stable currency, buoyant company earnings and the nation’s relatively low valuations in a world where other markets look pricey.
That’s required a rethink for Morgan Stanley. Until the past month’s pullback, they were predicting the Shanghai Composite Index, the benchmark for A shares, would outperform Hong Kong’s H stocks this year -- as it has during previous bull-market rallies.
But like many outside the mainland, the brokerage remain optimistic on China.
“We’d be more concerned about China macro risk if the offshore markets were also falling,” said Jonathan Garner, Morgan Stanley’s chief strategist for Asia and emerging markets in Hong Kong, who now says the MSCI China Index, which only tracks offshore Chinese shares, will continue to outpace the Shanghai gauge.
“Ultimately this is still a bull market,” he said. “We don’t think A-share weakness is signaling a major slowdown in growth.”
Dominated by tech heavy hitters like Hong Kong-traded Tencent Holdings Ltd. and the U.S.-listed Alibaba Group Holding Ltd., the MSCI China measure has emerged from the latest market gyrations basically unscathed. The gauge is close to a 22-month high, up 41 percent from a nadir reached in February last year.
Shanghai stocks, meanwhile, have gained just 12 percent in the same period -- a divergence that forced Credit Suisse Group AG to trim its Shanghai Composite targets with Morgan Stanley this month.
Evidence of a recovery in the world’s second-largest economy has helped keep international investors sanguine about China. The yuan is enjoying the calmest period since before its 2015 devaluation, and while China’s benchmark seven-day repurchase rate surged to a two-year high last month, it’s still far below peaks seen in 2015.
Meanwhile, earnings for companies in both the MSCI China Index and the Shanghai Composite are expected to rise the most since 2010 this year. The gauges trade at a discount of about 24 percent to the MSCI All-Country World Index, according to multiples based on projected earnings.
To CIMB Securities Ltd.’s Ben Bei, that means the hefty lead enjoyed by offshore shares may not last long.
“The divergence can’t widen that much further -- the valuation gap is no longer huge,” said Bei, director of the brokerage’s Hong Kong and China strategy. “Also in Hong Kong, ownership is far too concentrated on a handful of large caps, which could be a risk if earnings disappoint.”
The MSCI China’s surge owes a lot to rallies in Tencent and Alibaba, which make up about 25 percent of the index -- they were responsible for almost half of the gauge’s latest bull run, data compiled by Bloomberg show. Tencent jumped 1.6 percent on Thursday after posting better-than-expected results, while Alibaba is due to report later in the session.
Guo Min, research director at HSBC Jintrust Fund Management Co., is also worried about the central bank, which has been hiking interest rates with the Fed.
“Monetary policy is our biggest concern for now,” she said. “Further and excessive monetary tightening might cause corporate earnings to deteriorate.”
China’s deleveraging campaign has dethroned concerns about the euro zone for markets, according to a survey of money managers conducted by Bank of America Merrill Lynch.
But foreign bulls like Samy Chaar, chief economist at Banque Lombard Odier & Cie in Geneva, are sticking to their guns.
“We’re not frightened by any of this tightening in China,” he said. “It’s been very benign, narrow and it’s happening at a time when the economy is fine. Institutional investors were quick to understand that -- let’s see if onshore market players will catch on.”