It may have been rather overshadowed by the US presidential election, but this week’s changing at the top of the Chinese Party promises to be every bit as important for global investors. In fact a slow down in China’s growth would have a massive impact on the world GDP. 

The decisions taken by Xi Jinping, soon to be announced as the new President, will determine whether China is able to maintain its role as the engine of the world’s economy, or instead runs out of steam and has to abandon its ambitious growth plans.

The Chinese economy has slowed in the past couple of years as the recession in the developed West has reduced demand for its exports. This has been reflected in falls in the stock market. Chinese stocks fell by 17.8 per cent in 2011 and the poor performance continued into this year, but last month the market bounced back and Chinese funds were the best-performing sector in October.

So what is the outlook for the Chinese stock market? Let’s look atthe arguments for and against investing in China.

Advantages of China

The first big plus point is that this week’s announcement should end the political uncertainty and infighting that characterised the leadership struggle. Many of China’s local authorities and politicians had been sitting on the sidelines while the battle dragged on, and economic activity suffered as a result, says Martha Wang, manager of Fidelity’s China Focus fund. “I believe the conclusion to this contest will remove the political shackles that have been holding back the markets and we will also see a pick-up in the implementation of the Five-Year Plan,” she adds.

She thinks the political uncertainty has led investors to mark down stocks indiscriminately across the board, with the result that many fundamentally strong companies are now trading on attractive valuations. She also believes the new leadership will be prepared to tolerate slightly lower GDP growth, provided it is based more on higher-quality domestic consumption rather than cheap and cheerful exports.

Many people outside China have underestimated the strength of its consumer market, says Juliet Schooling, head of fund research at Chelsea Financial Services. China is about to overtake Japan as the world’s largest market for luxury goods and by 2013 it is forecast to have more middleincome households than the US.

Although the breakneck pace of growth has slowed, GDP is still expanding at more than 7 per cent a year — a rate that developed Western economies can only dream of.

Mrs Schooling says: “The market has been oversold and is now one of the cheapest among emerging markets. Although the short-term outlook is still a little uncertain there are big opportunities for long-term investors.”

China’s present round of spending to stimulate the economy is much more carefully directed than the one that was undertaken back in 2008, says John Ventre, manager of Skandia Spectrum funds. “The current spending, which we expect to continue under the new leadership, is more targeted, with a focus on sustainable energy and developing higher technologies,” he says.

Inflation is now under control, this offers the Chinese the opportunity to stimulate the economy should they need to do so.

Disadvantages of China

Although China’s population of 1.3 billion represents a huge domestic consumer market, it is also a rapidly ageing one. The present average age of about 35 is more akin to that of developed, rather than developing, economies, and the number of people aged over 65 is growing fast.

Another concern is the fact that most of the companies quoted on the Chinese stock market are effectively state businesses where the Government is the majority shareholder. This means that outside shareholders can exercise little control over the running of the companies and there is the continual worry that a company may pay greater attention to the needs of the Government than to the needs of its shareholders.  This can be counteracted to some extent by investing via HK companies that do business in China.

Even those who believe that China is an attractive place to invest are sometimes put off by the considerable volatility of its stock market. In 2003 the MSCI China index went up by 68.6 per cent and in 2007 it rose by 63.4 per cent. But in 2008 it went down by 31.2 per cent and in 2011 by 17.8 per cent.

There are a number of ways to invest in China . At deVere we offer notes investing in HK Chinese companies that protect the downside risk and still offer the potential of the upside. Personally I feel China offers great value and a Auto Callable note including the Chinese market offers great value.

Nigel Green deVere Group

Blog written November  10th