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Takeaway: Near-term policy catalysts will confirm the recent weakness across Chinese equities as either a head fake or an early warning signal.

SUMMARY BULLETS:

  • Keep an eye on China’s 12th National People’s Congress (which begins next week), as we’re likely to receive some much-needed clarity from Beijing regarding further curbs in the Chinese property market, as well as the introduction of several structurally-positive economic and socio-political reforms.
  • All told, we continue to like Chinese equities on the long side with respect to the intermediate-term TREND – particularly the consumption-oriented names as USD strength continues to deflate global commodity inflation in line with our expectations. Recall that the CNY is a tightly managed float vs. the USD, so the Chinese economy is particularly exposed to dollar strength/weakness in real-time.
  • Our updated quantitative risk management levels on the Shanghai Composite Index is included in the chart below. Holding above its TREND line of 2,209 would create a fantastic buying opportunity in Chinese equities. Conversely, a TREND-line breakdown would put our bearish Growth/Inflation/Policy scenario in play and force us to consider attacking this asset class or related asset classes (Australia?) from the short side.

THE FIVE W’S

Who: All eyes will be focused on the transition of power from outgoing President Hu Jintao to new Politburo Standing Committee #1 Xi Jinping and from outgoing Premier Wen Jiabao to new PSC #2 Li Keqiang.

What: 12th National People’s Congress

When: First plenary session begins MAR 5, 2013

Where: In China… Great Hall of the People, Beijing

Why: The seven new Politburo Standing Committee members will be “elected” to their official roles in the Chinese state government. Several avenues of [mostly positive] economic and political reforms are likely to be pursued:

  • POTENTIAL ECONOMIC REFORMS:
    • Interest rate liberalization
    • Capital account liberalization
    • Expanding the existing VAT trial to new industries and regions
    • Personal income tax reform (redistribution)
    • Social security expenditure reform
    • Energy tariff reform
    • Reduced reliance on SOEs in favor of SMEs
  • POTENTIAL SOCIO-POLITICAL REFORMS:
    • Hukou/urbanization reform
    • Land ownership and property registration reform
    • Increased intra-party democracy
    • Public disclosure of officials’ wealth and assets
    • Increased foreign policy aggression and assertion of territorial dominance (Japan)

*Note: Rather waste our time (or yours) with lengthy prose on each potential reform, we think it’s best to conserve our resources to direct our full attention to any actual reforms that are presented in the coming week(s). Moreover, it should be noted that both Jinping and Keqiang are rhetorically committed to a broad reform agenda, but any measures will likely be rolled out over several quarters and/or years amid opposition from entrenched special interest groups, such as SOE chair-people.

THE SIXTH "W"

Will the Chinese Communist Party throw down the gauntlet (again) upon the country’s property market; if so, will they do so at the current juncture?

The latest on this front is that the municipality of Beijing is reported to just have finished drafting further macroprudential tightening measures that are to be administered after the central gov’t issues more detailed policies. If this is true, then we may receive some additional clarity on this front next week shortly after the 12th National People’s Congress commences.

  • Best-case scenario (as well as our base case): Any new curbs are not overly punitive and much of the assumed impact has been priced in over the past few weeks of equity-market weakness (particularly amongst Chinese developers).
  • Worst-case scenario: The CCP drops the proverbial hammer (a la 2Q10) and threatens to derail China’s not-yet-stable intermediate-term growth outlook. This lack of true economic stability is evidenced by mainland rebar prices – which are still contracting YoY, but improving from a second derivative perspective.

 

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All told, we continue to like Chinese equities on the long side with respect to the intermediate-term TREND – particularly the consumption-oriented names as USD strength continues to deflate global commodity inflation in line with our expectations. Recall that the CNY is a tightly managed float vs. the USD, so the Chinese economy is particularly exposed to dollar strength/weakness in real-time.

Our updated quantitative risk management levels on the Shanghai Composite Index is included in the chart below. Holding above its TREND line of 2,209 would create a fantastic buying opportunity in Chinese equities. Conversely, a TREND-line breakdown would put our bearish Growth/Inflation/Policy scenario in play and force us to consider attacking this asset class or related asset classes (Australia?) from the short side.

Darius Dale

Senior Analyst

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