I spent the end of last week and the weekend in Hong Kong and Macau, meeting with a wide variety of institutional investors, hedge fund investors, family offices and investment bank/brokers. The timing of the trip was very good as it coincided with further massive upward price action in Chinese equities, which has relative and absolute ramifications for the region.

Chinese focus

Quite frankly, there was only one topic in Hong Kong last week and that was Chinese equities. Fair enough, the benchmark Shanghai Composite Index was up 8.3% last week alone, with Friday’s trading volume in China a staggering US$310 billion. Yes, US$310 billion. Tuesday’s was US$348bn!

These moves on huge volume do attract a disproportionate amount of investor interest: short-term traders want to be part of the action, long-term investors are scrambling to increase underweight exposure, and everyone else is scratching their heads.

I last wrote specifically on Chinese equities on the 14th of May. Since then the Shanghai Composite Index is up 12.5% and the AMP Capital China Growth Fund (AGF) up 21%. Hope you all bought some.

Let’s just update ourselves on year-to-date Chinese and China facing equity index performance in Australian dollars.

Clearly buying Australian resource stocks or New Zealand dairy stocks for leverage to “China” has not been the right approach this year. In fact, those stocks have broadly had an inverse correlation to Chinese mainland equities this year.

To benefit from the strength of the Chinese stock market you simply had to own Chinese equities, not a third derivative as such.

The real China play

Most Australian investors are still playing “China” through Australian resource stocks. That is not truly playing China: it is playing “iron ore”, “oil” or “coal”. In fact, many of the hedge funds I spoke to in Hong Kong were actually using Australian resource stocks as short funding vehicles for rotation to pure play mainland Chinese exposure. That is a popular trade that has worked very, very well this year.

As it was explained to me, that short/long bet is about betting on the drivers of Chinese GDP growth moving from fixed asset investment to consumer spending as incomes rise. There is also a consensus view that Australian miners have all overestimated Chinese steel production growth, yet are maintaining supply growth despite this clear overestimation of steel production growth. A couple of people I met were adamant that Chinese steel production had already peaked at 800mtpa and was actually heading down. Those people also believe the seaborne iron ore market will be oversupplied for at least the next decade.

Either way, everyone is entitled to their opinion and I certainty ran into no lack of them on my trip. And I used to think I was outspoken!

What does dawn on you in Hong Kong is how spoiled for choice regional investors are. At this moment in time, where the consensus view is the Australian dollar/US dollar has further downside and the broader ASX200 is “growthless”, this is to Australia’s detriment. There is a broad acknowledgment that Australian equities have a yield advantage over the region, but considering regional investors can’t value franking credits, that yield advantage is far less significant than in the eyes of an Australian investor who can value franking credits.

I came away feeling that Australian equities, not just resources, were being used as an underweight funding vehicle for higher growth rotation in the region. Global investors appear happy to forgo Australia’s yield advantage to get greater leverage to growth in the region. So far this year that strategy has worked well for them.

Let’s just remind ourselves of year-to-date performance in US dollars of major regional Asian markets

Australian and New Zealand equities are the big underperformers in US dollar terms this year and it’s hard to see what changes that if my view about the Australian dollar /US dollar cross rate heading below 70 US cents proves right as the year progresses. No doubt the ASX200 could advance to 6000 and beyond, yet, in US dollar terms, the associated currency fall would negate that move in US dollar terms.

My summary would be I didn’t feel any pressure on Hong Kong based investors/traders etc to cover underweights/short funding bets in Australian equities. They seemed comfortable in the positioning, particularly due to the fact their regional overweight/longs were adding large absolute and relative alpha. To see broad underweight/short covering in Australian equities, I suspect you’d have to see a large correction in Chinese equities. At this moment in time, I don’t think that’s likely.

The sector play

At a sector specific level, the most interesting conversations I had were about the Macau casino sector. A number of hedge fund operatives I respect believe the short trade in Macau casinos is “over” and it’s now a matter of working out the right timing to go long. Some had already started to build long positions to dip a toe in the water after a 50% correction in most Macau names.

The long Macau theory is based around the fact when good news comes (or more accurately no more bad news), you won’t have time to buy these stocks as they will all gap 20%. That’s probably good thinking and the general view is we are at the bottom in Macau sentiment with the stocks far more susceptible to unexpected good news.

We all know what’s happened in Macau: a Beijing led corruption crackdown has decimated the VIP and junket businesses leading to severe negative earnings revisions. That’s a known fact – well illustrated by the chart below of consensus Melco Crown Entertainment (MPEL) vs. consensus CY15 EPS estimates (red line). EPS estimates have halved and so has the share price.

However, the last month hasn’t see any consensus downgrades, which is interesting and it could well be that EPS is bottoming right now.

The same appears evident for Sands China (HK 1928).

And Galaxy Entertainment Group (HK 27)

Interestingly since I was last in Macau three years ago, the place has grown enormously. I was actually stunned by the growth on the Cotai Strip and a seemingly dramatic increase in domestic airlines at the airport. This was no ghost-town: far from it.

No doubt Macau was a short-term victim of its own success, with Beijing cracking down on corruption and obvious signs of corrupt wealth. That, in my view, is a short-term hiccup in what will be a long-term growth story.

In a market where everything else Chinese consumer facing is going bananas (rate cuts), I tend to think Macau casinos are cheap. It’s a contrarian idea and it revolves around a core belief that consensus negative earnings revisions are ending right now. I will only know if I am right about that in three to six months’ time, but the way markets work, I want to place the bet now (pardon the pun).

Remember, it was only 12 months ago that Chinese equity indices were as friendless as Macau casinos are right now. Below is a 1yr overlay of the Shanghai Composite Index (green) and MPEL (blue).

What to buy

For those of you who have missed the Chinese equity rally so far, or are trying to play China through Australian resource stocks, I encourage you to BUY MACAU casinos. If I am right and the tide turns, these pure play Macau names could have 100% upside, just like the Shanghai Index itself did from recent lows.

Melco Crown Entertainment (MPEL) just announced a $500m (5%) share buyback and that’s the one I’d be buying.

If your mandate or capability doesn’t allow you to directly invest offshore, then your first port of call should be Crown Resorts (CWN), owner of 33% of MPEL.

Crown (CWN), as somewhat of a Macau derivative, has been a volatile ride this year. However, I stand by my view that Crown will have a “2” in front of it as the rewards of its heavy regional capex program are reaped over the next five or so years.

If I am right and Macau bottoms, the Australian dollar keeps falling and Chinese international tourist numbers continue to rise structurally (buy SYD), then Crown will be a growth stock in an Australian market where large cap organic growth is getting harder and harder to find.

Crown’s forward FY15 P/E has dropped to 16.9x and FY16 P/E to 16x. That is effectively an ASX200 market multiple for Crown, which I think is undervaluing the medium to long-term growth potential versus the ASX/S&P 200.

In summary, after being in Asia, I remain a firm Chinese equities bull, broadly uninterested in Australian resource stocks, a firm Australian dollar/US dollar bear and a contrarian bull on Macau casinos and Crown Resorts (CWN).

If nothing else, the trip absolutely confirmed my view of investing in Australian equities for income, and the rest of the world (ROW) for growth.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.