China's Slowdown Comes to an End
Comment of the Day

September 09 2013

Commentary by Eoin Treacy

China's Slowdown Comes to an End

Thanks to a subscriber for this interesting article by Ashley Kindeman for the Financialist which may be of interest to subscribers. The full report is posted in the Subscriber's Area but here is a section
Now, the surgery. To set China on a path to sustainable long-term growth, the government must push through structural reforms that encourage private investment, Tao said. It could start by opening up China's service sector and cutting corporate taxes. More ambitious initiatives would include breaking up the banking monopoly and scrapping the hukou system, a household + registration system that makes it difficult for the waves of migrants who flock to China's cities from the countryside to access healthcare and education. Such fundamental reforms are absolutely critical to China's future growth because the current economic drivers – sky-high real estate inflation and local governments drowning themselves in debt to build more than they need – are tottering along on a high-wire that looks increasingly shaky. “Until structural reforms re-engage private investment, the growth is ‘buying time' because [both] the current housing rally…and local government investments are unsustainable,” Tao wrote.

The Communist Party holds a plenary session in October that could result in the announcement of some broad reform goals, but probably not concrete policy actions, he said. For that, China and investors will have to wait. “We believe that the Xi-Li regime (General Secretary Xi Jinping and Premier Li Keqiang) is committed to reform, but detailed structural reforms may not arrive as soon as October,” Tao wrote. Hard work lies ahead for Chinese officials to create the conditions necessary for stable, long-term growth, but at least China's recent decline seems to have run its course.

Eoin Treacy's view The once in a decade transition of power within China's single party system is a major event. While as investors we tend to be impatient for the kinds of reforms that will help create stock market value, the political timetable cannot be hurried. What does seem clear is that the new administration is reform oriented.

In concrete terms, the valuation contraction that has been in evidence in China for nearly three years appears to be coming to an end with some of the lowest P/E's of any major market.

The CSI300 Index has been ranging above 2000 for much of the year and is currently rallying from the lower boundary. Having experienced a precipitous decline from the February peak, the FTSE/Xinhua A600 Banks Index is rebounding quite emphatically and is now testing this year's progression of lower rally highs.

US listed China Fund Inc was trading at discount to NAV of 14% in June which has contracted to 10.2% today. Its holdings are reasonably evenly spread between mainland China, Hong Kong and Taiwan. The fund rallied last week to break the progression of lower rally highs from the February peak and a sustained move below $20 would now be required to question medium-term scope for continued upside.

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