Economic Analysis: China’s Equities Remain Bright

The economic outlook for China has not been very rosy, and it has become hard to ignore. However, we remain confident with China’s equity market as it has seen some pretty solid gains throughout 2014.

We have seen a dramatic and sharp slowdown with economic data in August. This is once again raising fears that the world’s second largest economy is about to experience a hard landing. However, we are seeing reforms emerging, like the second quarter reduction in the reserve requirement ratio from Beijing that are keeping us optimistic, especially with China’s equities markets. Today, Bloomberg reported a new stimulus package designed to inject money into the nation’s five largest banks.

The macro economy will, more than most likely, remain jagged and uneven. However, we should look at their reforms agenda. That agenda should be considered the new stimulus for China and investors have been underestimating the resolve of Beijing to implement reforms.

The momentum surrounding reforms is gaining steam since the Third Plenum met in November. The country’s top leaders, committed to push reforms for financial liberalization, especially with state owned companies. The new National Development and Reform Commission (NDRC) was a key release regarding new economic priorities for the Beijing. This report announced measures to reduce existing administrative approvals and therefore encourage private investment of capital. It also announced targets to accelerate opening the service sector as well as going ahead with measures to open the country’s capital account.

This was a huge step in the right direction with regards to help transform China into a consumption based economy. Liberalization of the capital account will come into effect in October. The scheme, based on a “through train,” will allow foreign investors to place buy and sell orders on the Shanghai A-share market. Investors in China will be able to use Chinese, mainland brokers, to open buy and sell orders in Hong Kong’s H-share market. The name of the scheme will be the Hong Kong Stock Connect.

This is an important and necessary first step by China to open the capital markets. Foreign investors will have easier access to mainland Chinese stocks and Chinese investor will access Hong Kong stocks easier. This will make it easier to invest in China’s economy. However, investors are not fully appreciating these reforms. Investors need to shift their focus. Right now they look at short term economic cycles. They need to shift to the government’s initiative of pushing through reforms. When Fourth Plenum meets in November, they should really look at judicial reforms.

Beijing is starting to reform its tight hold on residence registration. This system, known as hukou, denies basic services to people who want to relocate without government permission. This has caused social unrest and made it harder for rural China to move to urban China to find jobs.

Over the next several weeks, we are also expecting the People’s Bank of China (PBOC) to roll out more target stimulus plans to help spur the lagging economy. These will include measures to support infrastructure projects as well as relaxing property market taxes and further ease monetary policy. In other words, we expect the PBOC to cut its key lending rate sometime in the near future. If they do not go that route, they will cut the reserve requirement ration further or increase bank lending. This should help curb the fall off we have seen with the industrial production numbers.

This means stocks on the Shanghai should continue to outperform their peers. Over the last three months the Shanghai has seen an impressive rally as it is up more than 12 percent on earlier strong economic data. The easy monetary policy has helped and will continue to help as we get more supportive policies emerging from the PBOC and Beijing.