Thematic Investments: China's New Leadership
Consensus politics should underpin policy continuity: growth stabilization and structural reforms
Leadership transition removes political overhang
- Completion of the leadership transition at the 18th National Party Congress has removed a major political overhang from the Chinese and Hong Kong equity markets.
- We believe consensus politics will underpin policy continuity. The new leadership is expected to focus on growth stabilization in the near term and structural reforms in medium term.
- We believe China H shares and Hong Kong offer attractive valuations due to bottoming earnings momentum, attractive valuations and improving technicals.
Policy continuity but no major stimulus
- After months of intense political rivalry and factional struggles, the Chinese Communist Party yesterday completed its once-in-a-decade power transition at the First Plenary Session of the 18th Central Committee. As expected, the Politburo Standing Committee, the most important policy-making body in China, was reduced from nine to seven members. Vice President Xi Jinping was elected as the Party General Secretary and Chairman of the Central Military Commission. Vice Premier Li Keqiang is expected to take over the Premier position at the First Plenary Session of the 12th National People’s Congress in March 2013. The conclusion of the 18th National Party Congress marks the beginning of the Xi-Li leadership, the fifth generation leadership of the world’s second largest economy. We believe the successful completion of the power transition will remove a major political overhang from the Chinese and Hong Kong equity markets, as the new leaders are expected to shift their policy focus away from political rivalry back to economic policymaking ahead of the State Council reshuffle at the National People’s Congress next March.
- Hu’s full retirement offers Xi a stronger power base. While the succession of the Xi-Li leadership came as no surprise to the market, the retirement of President Hu Jintao from chairmanship of the Central Military Commission did surprise political observers. Unlike his predecessor, former President Jiang Zemin, who remained as Chairman of the Central Military Commission for two years after his retirement from the party chief position, Hu decided to hand over the Central Military Commission chairmanship to Xi. This will give Xi a stronger power base with full control over the military from day one of his succession to power.
- In our view, the new leadership is unlikely to bring a material change to the monetary and fiscal policies in the short term. Given the latest signs of growth stabilization, the urgency for China to launch major stimuli to revive growth has declined. We do not expect any cut in interest rates or the reserve requirement ratio (RRR) before the end of this year. More importantly, we believe the new leadership would show a higher tolerance to more moderate headline growth as their strategic focus has shifted to economic rebalancing in order to shift the growth model from the export-led and investment-driven strategy to a more sustainable consumption-driven growth model. We also think the current restrictive property policy is likely to stay, as the risk of a property bubble remains a concern of the central leaders.
- Central Economic Work Conference is the next focus. The next important event that will shape monetary and fiscal policies for 2013 is the Central Economic Work Conference, which will convene in mid-December. With China’s economy showing clear signs of growth stabilization, fiscal and monetary policies are likely to remain neutral in the short term. The Central Economic Work Conference is expected to review the key economic targets for 2013 and reaffirm the proactive fiscal and prudent monetary policies. Based on Hu’s work report to the 18th National Party Congress, the Chinese leaders will remain focused on growth stabilization as the top policy priority for 2013. We expect the reduced political uncertainty over the central and regional leadership reshuffle to help unleash pent-up investment demand of the Chinese enterprises in the coming months.
- Structural reforms will take longer to materialize Since the reshuffle of the State Council will only take place at the next National People’s Congress in March 2013, we do not anticipate any material structural reform to be announced in the short run. It is noteworthy that leaders of the key central ministries and regulatory bodies in charge of important economic and financial reforms have just retired from the Central Committee after the 18th National Party Congress, including the Governor of the People’s Bank of China Zhou Xiaochuan, the Chairman of the National Development and Reform Commission Zhang Ping and Finance Minister Xie Xuren. Since membership in the Central Committee is a prerequisite for ministerial positions in the State Council, this means that they will step down from their government positions in March 2013.
- Taking into account the upcoming State Council reshuffle,we believe crucial structural reforms such as exchange-rate reform, interest rate liberalization, state-owned enterprise (SOE) reform and capital market reform is unlikely to take place before the new leaders of the central bank and the central ministries fully settle down after the personnel changes.
Shanghai Faction versus Communist Youth League.
Consensus politics underpins policy continuity
- Looking at the composition of the new Politburo Standing Committee, only Li Keqiang is regarded as a close protégé of Hu due to their political ties established in the Communist Youth League. Three new members in the Politburo Standing Committee, Zhang Dejiang, Yu Zhengsheng and Zhang Gaoli, are widely regarded as close protégés of Jiang. Wang Qishan, the newly elected Secretary of the Central Commission for Discipline Inspection and Liu Yunshan are known to have good relations with both Jiang and Hu.
- Some investors expressed concerns about the perceived victory of the “Shanghai Faction” led by Jiang and setback of the “Communist Youth League Faction” led by Hu at the 18th National Party Congress. We are not concerned about the close political ties of the Politburo Standing Committee members with the “Shanghai Faction“ given the fact that China’s most important and progressive market-oriented reforms were introduced under the leadership of Jiang and former Premier Zhu Rongji during 1989–2002, including China’s admission to the WTO, SOE reform, banking sector reform and private housing reform. We do not expect the factional background of the new leaders to have a fundamental impact on China’s macroeconomic policy outlook.
Investment implications of the leadership transition
- The election of the new Politburo Standing Committee is an outcome of consensus politics in China. We expect the new leadership to strive for policy continuity rather than drastic changes to the existing reform programs to ensure growth stability.
- From engineers to social scientists. When compared to the technocratic background of the Politburo Standing Committee members elected ten years ago, the new Politburo Standing Committee is dominated by social scientists rather than engineers. As a chemical engineering graduate from Tsinghua University, Xi Jinping also obtained a doctoral degree in law while Li Keqiang obtained his doctoral degree in economics at the Peking University. Out of the remaining five Politburo Standing Committee members, both Zhang Dejiang and Zhang Gaoli were trained in economics while Wang Qishan and Liu Yunshan obtained their degrees in history and politics, respectively. Only Yu Zhengsheng has a pure technocratic background with his degree in military engineering. As China is entering a new phase of economic reforms with the strategic focus shifting from industrialization to economic restructuring, the professional background of the Politburo Standing Committee is also witnessing a structural shift from technocrats to social scientists who are better equipped to manage the new social, political and economic challenges arising from China’s economic liberalization and the new global economic order.
- While we do not expect major policy easing nor significant structural reforms to take place in the near term, we believe China’s growth stabilization and diminishing political uncertainties are supportive drivers for Chinese and Hong Kong equities. The latest economic data provide further signs of the bottoming out of China’s economic growth momentum, which has attracted strong rotation flows into Chinese and Hong Kong equities since early October. The latest monetary data in October show the strong rise in total social financing to CNY 1.29 trillion in October from CNY 504 billion a year ago, suggesting an expansionary policy setting that should support growth stabilization and further improvement in the PMI in the coming months.
- Rebound of China earnings revisions, undemanding valuations and improving technicals support our investment thesis on Chinese shares. We believe the worst negative earnings revisions should have occurred in September as analysts caught up with cutting their earnings forecasts after the H1 2012 results announcements. The latest IBES data reveal that Chinese earnings revisions are stabilizing as the 3-month rolling data has turned less negative compared with numbers in July-August. The HSCEI, HSI and Shanghai Composite Index (SHCOMP) are all trading at the 2008–09 crisis low P/E 2013E of 6.9, 10.1 and 8.1, respectively.. But we continue to prefer the HSCEI over SHCOMP, given the latter’s new-share supply overhang from unlocked shares and new fundraising.
- To position for China’s growth stabilization and reduced political uncertainties, we recommend that investors focus on undervalued quality Chinese stocks that are poised to benefit from stabilizing growth momentum in China.
CNY and CNH set to sustain appreciation trend
- The Chinese renminbi (CNY) has just
reached a new all-time high versus the USD. Given the positive Chinese
economic data, USD weakening triggered by QE3 and concerns over the
fiscal cliff, we expect the CNY to sustain its appreciation trend. We
forecast USD/CNY at 6.23 in 3 months and 6.20 in 12 months. We remain
long on 12-month CNH (offshore CNY traded in Hong Kong) deliverable
forwards against USD with a target of 6.30. We also recommend selected
quality CNH bonds and Chinese hard-currency bonds to gain exposure to
the China recovery theme. We have a BUY recommendation on SOHO China
2017 bond, which is the highest-rated privately owned Chinese property
company, with 100% exposure to the commercial property market in Beijing