Inflows from the mainland have helped Hong Kong’s benchmark equity gauge climb 22 percent this year to outperform most global peers. Onshore shares have largely been left behind amid concerns about rising funding costs, corporate governance issues, liquidity pressures and tougher regulatory oversight.

Chinese investors have bought about 35 billion yuan ($5.18 billion) worth of Hong Kong stocks in July as of Friday, surpassing June’s total monthly net purchases according to Bloomberg calculations.

“Mainland investors are buying Hong Kong stocks to diversify their portfolios and hedge risks, thanks to the weak performance of mainland equities, especially the ones listed in Shenzhen," said Banny Lam, managing director and head of research at CEB International Investment Corp.

The ChiNext, cowed by an official battle against speculators, is on the verge of becoming cheaper than the Nasdaq Composite Index for the first time on record. Its valuation based on reported earnings is now at 36.2, compared with 34.3 for the Nasdaq, leaving the narrowest gap since the Chinese board started in 2010.

Eoin Treacy's view

The upcoming Party Congress slated for September or October represents a pivotal transition for the Chinese administration. This event is more important than any in at least the last fifteen years because so many members of the Politburo and Standing Committee have reached retirement age. It represents a key opportunity to cement power for the existing team by appointing their own people into key positions of power they could occupy for the next decade.

From a political perspective to say the stakes are high is an understatement. The administration clearly wishes to dispel any criticism of their means or even appearance so ensuring the stock market does not become a source of embarrassment is a powerful potential bullish catalyst over the coming months.  

The Chinext Index of small caps is one of the world’s worst performing stock market indices this year. While oversold in the short-term, a break in the medium-term progression of lower rally highs will be required to question the medium-term downward bias.

The Shenzhen B Share Index is testing the upper side of an almost two-year range and a sustained move above 1200 would signal a return to medium-term demand dominance.

The Hang Seng Index bounced from the psychological 25000 level earlier this month and while somewhat overbought in the short-term a break in the 18-month progression of higher reaction lows would be required to question medium-term scope for additional upside.