SSEC: Don't fight the PBOC

Some blue chip Chinese companies have dual listing. They are listed on Shanghai Stock Exchange as well as Hong Kong Stock Exchange. Their shares that are listed on the Shanghai exchange are known as A-shares while those listed on the Hong Kong exchange are known as H-shares.

The shares of the same companies but listed on different exchanges have different prices- with the A-shares trading at a premium over H-share counterparts. There is no way to bridge the difference as there is no channel for arbitraging. The difference is attributed to imbalances between supply and demand.

There is an index called “Hang Seng China AH Premium Index" which tracks the spread between the A-shares and H-shares. Over the past 1 year, the spread has expanded from 90% to above 140%. During the sharp downturn last week and the early part of this week, the spread corrected back to a more normal 125-130%! However, due to the strong rebound over the past 2 days, this spread has widened to 150%!

If we used this spread as the measure of sustainability, then we can conclude that the current rebound in Shanghai must lead to one of two things happening: The A-shares must drop back or the H-shares must catch up. I am inclined to believe that the former scenario is more likely to pan out than the latter scenario. 

From the chart below, we can see the sharp rebound in SSEC & the Hang Seng China AH Premium Index. SSEC index will face strong resistance at the psychological 4000 mark or the horizontal line at 4100. I doubt it can surpass these level so soon. Nonetheless, we must acknowledge the huge rebound in SSEC index- a gain of 14% in 2 days! (Note: SSEC was trading at 3877 as at 3.00am EDT.)

Chart: SSEC's daily chart as at July 9, 2015 (Source: Stockcharts)