Hong Kong's Hang Seng Index Poised for More Volatility

Is the Hang Seng Index setting itself up for a fall?

A pair of companies that have been among the hottest stocks in Hong Kong are about to enter the market's 50-constituent benchmark, which has jumped 32% this year and is one of the world's best-performing indexes.

Chinese developer Country Garden has nearly tripled this year, while Sunny Optical, which makes lenses for smartphone cameras, has quadrupled. They will join the Hang Seng Index on Dec. 4, replacing Cathay Pacific Airways and gas storage-and-transport firm Kunlun Energy, 62%-owned by China National Petroleum. CNPC, a state-controlled firm, also owns 86% of another Hang Seng component, PetroChina.

Hong Kong stock-index compiler Hang Seng Indexes said in a statement the changes are part of a quarterly review, but didn't elaborate.

The criteria for membership in the benchmark includes being in the top 5% of stocks on the Hong Kong Stock Exchange by market capitalization. Cathay Pacific, which was swiftly added to the index after going public in 1986, has a market cap of 48.5 billion Hong Kong dollars (US$6.22 billion). Along with Kunlun, which has a market value of HK$57.5 billion, they are the two smallest companies in the index by weighting.

Property stocks have been on a tear in 2017. Some have grown five or six times since the beginning of the year, as real-estate prices in Hong Kong and China continue to climb.

Tech stocks in Asia have been almost as hot. Tencent's Hong Kong-listed shares have doubled this year, contributing to the Hang Seng Index's strength.

That raises the question of whether both sectors are due for a correction, given frothy valuations. Property and construction firms make up a fifth of the Hang Seng Index, while Tencent, computer maker Lenovo and components supplier are the three information-technology firms on the benchmark.

The index would have seen even bigger gains this year if it weren't for a rule limiting components to a 10% weighting. That effectively puts Tencent on par with HSBC, even though the bank's market cap is less than half of Tencent's nearly US$470 billion.

Among other changes taking effect Dec. 4, Guangzhou Auto will replace China Longyuan Power in the Hang Seng China Enterprises Index, which tracks Hong Kong-listed Chinese companies. The H-share benchmark is up 25% this year, with Longyuan down slightly and Guangzhou Auto more than doubling. Here, too, it seems that a depressed stock is being swapped with an inflated one.

As for Cathay Pacific, its shares have rebounded 21% this year, but at HK$12.34, they pale in comparison to the HK$20 level at which they traded in mid-2015. Kunlun has gained 23%, but remains at half the level it traded four years ago.

Write to Kevin Kingsbury at kevin.kingsbury@wsj.com

(END) Dow Jones Newswires

November 11, 2017 01:28 ET (06:28 GMT)