A Hong Kong Opening

The stratospheric rise in the domestic Chinese stock markets continues to raise speculation that the bubble has reached an unsustainable level.

The Chinese government has been attempting to cool the markets and to curb speculation for months. Undeterred, the local markets continue to move higher as retail investors have continued to pour more money into stocks.

A change in government policy is now putting the spotlight back on Hong Kong, where value can still be found. The Chinese government is now allowing individual retail investors to invest directly in the Hong Kong stock market.

The new policies are expected to draw significant inflows into the market, which historically has offered investors stability in a region known for its instability due to Hong Kong's strong economy, stable political environment, and defensive characteristics. An SG Securities trader estimates the government is going to allow $240 billion to be invested into Hong Kong by Chinese retail investors. Today, a Credit Suisse equity strategist upgraded Hong Kong from MarketWeight to Overweight

As a result of the policy change, all of the major indices in Hong Kong have been trading higher. On Monday, all of the majors gained between three and six percentage points.

The Hang Seng Index, which is up 18% to date, trades at an attractive multiple of 15.8x trailing earnings - in line with its 5-year historical average. The "Red Chips" or Hang Seng China Affiliated Corp Index (HSCCI) trades at 23.7x, but it's the H-Shares that remain the favored play, gaining 6% overnight and sending the index to multi-year highs.

The Hang Seng China Enterprise Index, or H-Shares ,as it's known, has gained 17% over the past week bringing its year-to-date total return to over 35%. The Index, which is comprised of state-owned Chinese companies, trades at 23.9x on a trailing multiple versus the Shanghai A-Share Index at 50.6x and the Shenzhen A-Share Index at 70.0x. Furthermore, rising earnings expectations for H-share listed companies is only adding to the heightened interest in these stocks.

Last month mainland authorities allowed investors into the Hong Kong market on a pilot basis, hoping the participation would lift valuations. The expected surge in inflows, coupled with the attractive valuations, makes the H-shares the names to own.

There are a number of H-Shares stocks that trade as ADRs in the US, although the liquidity varies considerably. These include: Aluminum Corp (ACH), China Mobile (CHL), China Telecom (CHA), Guangshen Railway (GSH), Huaneng Power International (HNP), China Life Insurance (LFC), PetroChina (PTR), Sinopec Shanghai Petrochemical (SHI), China Petroleum and Chemical Corp (Sinopec) (SNP), and Yanzhou Coal Mining (YZC).

There are three main ETFs for Hong Kong including the Hong Kong iShares (EWH), the Powershare Golden Dragon Halter USX China Portfolio (PGJ) and the FTSE/Xinhua China 25 Index (FXI). (See charts below.)

--Kimberly DuBord, Briefing.com