Short bets on Hong Kong stocks have hit a historic high. The trade has been a profitable one so far, with the city’s benchmark Hang Seng index down nearly a quarter in the past year. That has made short selling Hong Kong stocks look a surer bet than it really is.
Short-selling trades as a proportion of the total turnover on the Hong Kong’s stock market this week climbed to a record 23 per cent this week, according to Bloomberg data.
Much of the bearishness is justified. Regulatory risks remain high for the Chinese tech groups that dominate the city’s benchmark index. Their prices have also been dragged down by the fear that their American depositary receipts will be compulsorily delisted.
Big investors have been reducing their exposure. Warren Buffett’s Berkshire Hathaway has just trimmed its stake in Hong Kong-listed Chinese electric carmaker BYD. The move triggered a disproportionate drop in the shares.
Still, the large volumes of shorts are surprising. Hong Kong restricts the activity. Naked shorting — selling shares that traders do not own or have not borrowed — is banned. This means short sellers have to pay up to borrow the stock. Returns on successful short sales are correspondingly lower than in markets such as the US. An uptick requirement means short sales must be made at a higher price than the previous trade.
Hong Kong’s short sellers are now vulnerable to short squeezes. Trading volumes in Hong Kong have fallen in recent months, increasing the potential for sharp, hair trigger price movements. The main targets of the short bets have been big Chinese blue-chips. These popular names, which include giants such as Tencent and Alibaba, have large, loyal, long-term retail investor bases. That makes covering short positions pricey.
The Hang Seng index, which now trades at just 0.8 times book value, looks dirt-cheap compared with regional peers. The lower the valuation of Hong Kong stocks fall, the higher the risk of a short squeeze in coming weeks.