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How to Take Advantage of the Biggest Anomaly in Finance

Monday, July 18, 2016 5:24

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It is, in my opinion, the biggest anomaly in finance…

Just think about how crazy this is for a second…

Apple, for example, trades for around US$100 a share.

But imagine for a moment that you could buy the identical shares today in Canada for US$70 a share.

I promise, there is no difference in the shares – at all. The only difference is that these shares trade on another stock exchange.

What would you do?

A smart investor would buy those Canadian-traded shares, right? A smarter investor would sell his U.S. Apple shares for US$100 and use the proceeds to buy the shares in Canada at US$70.

A hedge-fund manager would take it one step further… and sell short at US$100 and simultaneously buy at US$70.

This situation is happening right now. Some of the world’s biggest companies trade on two different exchanges, at massively different prices.

In China, identical shares of many companies trade in Hong Kong (called “H” shares) and in Shanghai (called “A” shares).

In recent years, the so-called “A-H premium” soared to nearly 50%. That means you’d pay 50% more on average for the same stock in Shanghai versus in Hong Kong. It’s crazy. Take a look…

These are some of the world’s largest companies. These premiums shouldn’t exist – but they do. That’s why I called this the biggest anomaly in finance.

With the Hong Kong/Shanghai “Stock Connect” in place, it should be even easier for investors to instantly buy for $70 in Hong Kong and sell for $100 in Shanghai, so to speak.

I was in China earlier this month. While visiting Hong Kong and Shanghai (and Beijing), I repeatedly asked the top guys at the best firms why this premium is so crazy.

“Don’t you agree the A-H premium will go away eventually,” I asked.

“Of course,” everyone answered.

“But when?” I asked. “Why does it even exist today?”

And that’s when the stumbling started. The reality is, not a single expert gave me a decent answer.

Here’s a common answer I heard in Shanghai: “Sometimes when your home market is doing well, you don’t look outside your borders for better values.”

That answer doesn’t hold up, though… First, Shanghai’s market hasn’t been doing well. And second, people are surprisingly crafty when it comes to eking out a buck. If there were a way to get a $2-per-share-better deal, people would do it. A $30 better deal is crazy.

Here’s another common answer: “Chinese market players are typically individual investors who are gamblers, gambling on our local market.”

Again, it doesn’t hold up… Gamblers are crafty, too. If there’s a better way, they’ll find it.

Right now, companies listed in China are selling for a roughly 30% premium to the identical companies listed in Hong Kong.

So what should you do? You should buy the Chinese companies listed in Hong Kong!

The simplest way to do that is through the iShares China Large-Cap Fund (FXI).

Get this: Three of FXI’s top five holdings trade at a forward price-to-earnings ratio of just 5. That is absurdly low.

I wish I had a great answer for you for why the greatest anomaly in finance exists. Believe me, I tried. I heard plenty of answers – but no good ones.

For now, I recommend taking advantage of it… by buying Chinese companies trading in Hong Kong. FXI is the easy way to do it…

Good investing,

Steve

Source: http://www.stansberryresearch.com/dailywealth/3316/how-to-take-advantage-of-the-biggest-anomaly-in-finance

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