Will China's 2014 continue to be year of the bull?

Positive but subtle changes are taking place in China

If the sweeping economic reforms planned by Chinese leaders during the Third Plenum can be our guide, it looks to be a promising decade for global investors. Details released recently confirmed President Xi Jinping’s concerted efforts to move China toward a market-based economy that mirrors the West.

The plan’s comprehensive nature and the level of clarity evidently pleased investors, as many Chinese stocks experienced a pop.

We believe the positive effect on the equity markets will not be short-lived or limited. A component of U.S. Global’s investment process is to closely follow government policies because they tend to be precursors to change. Xi’s policies, if successfully implemented, “will undoubtedly have profound long-term implications for the Chinese economy and society at large,” spanning economic, political, cultural, social and environmental issues, states BCA.

Some say the sweeping reforms will have an impact similar to the momentous changes following the Third Plenary Session in 1978, when Deng Xiaoping instilled the concept of free markets and ushered in a new economic era.

“Covering 15 major areas and 60 key points, the document is specific, substantial, comprehensive and actionable,” says Jefferies. The changes are so significant, it “rivals that of 1978, when Deng Xiaoping declared the opening of China,” says the research firm.

Michael Ding, CFA, portfolio manager of the China Region Fund, shared his thoughts regarding these sweeping changes and the potential effects on the markets. He has fascinating insight on this subject, as Michael grew up in rural Dalian and is of the same generation as the nation’s leaders. This age group was raised in the era of severe government controls, such as food rations; still fresh in their leaders’ minds was the stagnation of the country.

Improving market inefficiencies is one significant and positive effect, Ding says. Currently, government interventions prevent companies from setting competitive prices. Releasing control should allow the market to decide what prices should be and where labor and capital should be allocated.

BCA states that three areas likely to see improvements in pricing mechanisms include money, resources and land. Changing the pricing mechanism of money influences the exchange rate and interest rates. The research firm says that “the proposed reforms involve freer cross-border capital flows, improved convertibility of the RMB and eventually a market-driven floating exchange rate system.” In addition, more liberal interest rates should allow markets to price capital based on risk and supply and demand, says BCA.

When it comes to resources, the government plans to reduce subsidies and “administrative meddling” in several sectors, including water, petroleum, natural gas, electricity, transportation and telecommunications, which should allow for more competition, according to BCA.

The reforms affecting the pricing mechanism of land will likely allow for the equal treatment of rural and urban lands. Whereas the government formerly seized rural land, people who live in rural areas in the future could “monetize the rising value of rural residential land” and ease supply shortages in major cities, states BCA.

Included in the considerable social changes are relaxing the one-child policy and reforming the hukou system, which is China’s residency status system. Now, couples will be allowed to have two children if one parent is an only child. This change wasn’t a surprise to us, as it follows the rise we’ve seen in birth rates in recent years. As you can see below, the number of annual births in China has been increasing since 2011. In many cases, with rising incomes, couples can afford to pay the required fine.

Changing the one-child policy could be the beginning of a rising demographic cycle in China, which bodes well for a wide range of companies. The country may see an increase in demand for residential housing and social housing, income protection products, and child-targeted products, such as infant formula. The change may also boost demand for larger vehicles, such as sport-utility vehicles, and Internet companies could benefit from increased users in the years ahead, according to Citi Research.

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