Short-Term Trades Unclear With Chinese Communist Party Transition

 |  Includes: FXI
by: Emerging Money

By David Riedel

The opening today of the Chinese Communist Party Congress, which will oversee the once-in-a-decade transfer of power, will likely raise questions of what the impact of this political change is on Chinese stocks and markets worldwide. We will address some of those issues here:

  1. We don’t believe that the transition in Chinese politics sends any strong actionable signals for traders in Chinese markets near-term. In Chinese politics one does not get ahead by highlighting change and what will be different under your administration, but rather by emphasizing loyalty to the incumbent and stability. In this context it is unlikely that the incoming leaders will make any significant sudden changes early. To do so would be an insult to the outgoing leaders implying that they were doing something wrong and you are here to fix it. Do not expect any significant changes in the near term.
  2. The new administration could be quite good for U.S.-China relations. The expected incoming president Xi Jinping has strong relations to the U.S., having visited many times and even having a daughter studying at Harvard.
  3. This affinity for the U.S. is one of a number of things that makes the incoming leaders unique. Importantly, this is the first generation of leaders who grew up during the cultural Revolution. Xi Jinping, for example, was born in 1959 and spent most of his formative years (1969 through 1975) working as an agricultural laborer in his ancestral province of Shaanxi. He shares this experience with many millions of other Chinese of his generation and as a result has a strong respect for and commitment to farmers and rural China.
  4. Another way that Xi Jinping is different from the outgoing group leaders is his experience with the military. He spent many years working with the military including his first job in politics. He is seen as a strong supporter of the military and we will likely hear strong nationalist rhetoric directed at Japan as the ongoing dispute between the two countries continues to be a headline risk for Asian investment.
  5. Xi Jinping is seen as a "fixer," a well-connected and loyal politician with their wide range of skills. He was appointed party chief to Shanghai after a scandal there in 2006, euros heavily involved in preparations for the 2008 Beijing Olympics as well as recovery efforts for the devastating Sichuan earthquake in that same year.

While I wouldn’t hold my breath for any dramatic changes in policy in China in the coming weeks or even months, I am optimistic that this skilled group of technocrats will continue to manage Chinese society and the Chinese economy effectively. External shocks like the global financial crisis remain the biggest risk to the Chinese economic story. We believe the ongoing effort to increase domestic consumption and consumer activity will, over time, reduce the importance of external trade and external shocks. Domestically, social unrest remains a key issue for Chinese leadership. A continued focus on corruption and improving the lives of the hundreds of millions of rural and poor Chinese is critical to maintaining social stability.

We believe investors should be building positions in Chinese equities on the expectation that the next six months be better than the last six months in terms of sentiment and performance.