China’s New Leadership: An Uncertain Trumpet

Editor’s Note: Happy Thanksgiving! I hope you all have safe travels and enjoy a terrific holiday with family and friends.

China’s leadership transition has underwhelmed investors. However, even if true reform doesn’t immediately become apparent, the new government in China is likely to implement stimulus policies that benefit Chinese stocks.

A week ago, China’s Politburo Standing Committee—the top governing body in the country—was reshuffled in its decennial reconstitution. Given that the change is hugely important to China’s future policy direction, and consequently its economic growth, I’ve written about that change quite extensively over the past few weeks, both in Passport to Profits and The Global Investment Strategist.

I’ve been struck by the tepid response of the markets to the transition. I made the point last week that it’s impossible to know the true intentions of China’s new party chairman Xi Jinping, given the tight control the Chinese Communist Party has kept on the flow of information. However, he has been widely heralded as a moderate at worst and a reformer at best.

In his inaugural speech as party chairman, Xi spoke about working to stamp out corruption in government and the importance of smoothing out income inequality and enhancing the material wealth of the Chinese people. While he said nothing about greater political freedom, his speech hinted that over the short term more stimulus efforts are likely and over the long term he will reorient the economy toward domestic demand.

Given his encouraging words, I expected the Chinese equity market to react favorably to Xi’s ascension to power. But so far the Shanghai A-Share market is off by about 1.5 percent—it hasn’t had an up day since the Politburo announcement—and the Hong Kong market has fared only marginally better.

There has been some less-than-positive news recently, such as the drop off in foreign direct investment. However, it appears that the market either expects the Chinese slowdown might be more than the government can handle or that Xi’s image as a reformer is mostly hollow.

Another potential explanation is that Xi’s seemingly progressive tendencies might be outweighed by the more stolid, old-school traditionalists represented on the Politburo Standing Committee, including Xi’s second-in-command Li Keqiang. While they’ll likely go along with most anti-corruption efforts, their loyalties lean toward the more prosperous coastal provinces which have benefitted from China’s export economy.

This rear guard would probably resist any attempts to funnel more wealth into the country’s interior provinces. They’ll certainly fight initiatives to loosen China’s political strictures, if Xi has any inclinations in that direction.

It will take time to see how these broader issues ultimately shake out, but short-term stimulus efforts are virtually inevitable. As I’ve written before, the days of 9 percent-plus gross domestic product growth are over for China. Over the next few months, I expect the government to provide support in the form of subsidies on big-ticket consumer goods and an interest rate reduction.

The government will be eager to placate the average Chinese citizen by showing the benefits of the newly installed leadership. Any stimulus announcement is bound to create a pop in China’s equity market, so don’t count out Chinese equities—even if no political reforms immediately materialize.