Chinese shares are on the up.
Investors are excited by the results of last week’s crucial Communist Party meeting.
The party leadership revealed that the country’s ‘one-child’ policy would be partially relaxed, while the economy would be liberalised.
These measures include giving improved property rights to farmers and making it easier for financial institutions to go bust.
These are all very welcome changes. And they strengthen my belief that now is a good time to make a modest investment in China…
Big changes ahead for China
China’s big Communist Party meeting was what they call a ‘third plenum’ meeting. These happen every ten years, and they’re seen as particularly important because they allow a new party leadership to set out its plans.
Initial reports of the meeting were based on a communiqué issued last Wednesday and were pretty downbeat. Seemingly not much had changed.
However, more detailed reports of the meeting emerged last Friday and the mood changed. It looks like the new leadership really does want to push through genuine change.
The headlines have mainly focused on proposed changes to China’s ‘one child’ policy. The changes mean that more couples will be allowed to have two children, although some will still be restricted to one child. (The rules depend on whether parents were themselves only children or not.)
These changes are welcome because China faces a looming demographic crisis. China soon won’t have enough people of working age to support its elderly population.
This problem is so serious that I think the government should have liberalised further, but at least things are moving in the right direction. The changes also have real symbolic value – making a clear shift on such a high-profile issue helps to demonstrate that the leadership is serious about having an impact.
But we shouldn’t just focus on the one-child changes. The plenum’s economic proposals are important too. In fact, Dong Tao, chief regional economist at Credit Suisse, told the FT that the package was “the most comprehensive and ambitious reform plan in the history of the People’s Republic.”
Perhaps the most significant change is the lifting of price controls in some areas. This means that markets will now play a ‘decisive’ role in the allocation of resources rather than a ‘basic’ role. Some protections for financial institutions will also be lifted – this means the chances of a bank going bust will increase.
On top of that, farmers will be granted more rights over their property while it will become easier for rural citizens to migrate to some Chinese cities. Once the new migrants arrive, they will be given increased rights over property and where they can work.
Changes will also affect the big state-owned companies. They will be expected to pay at least 30% of their profits out as dividends by 2020.
This isn’t a revolution – don’t expect a free market in China
Don’t get me wrong. We’re not about to see a true free market in China. And there is huge uncertainty about whether these changes will be fully implemented.
What’s more, the Chinese Communist Party clearly has no intention of modernising China’s political system or even introducing appropriate checks and balances such as an independent judiciary. That means corruption will probably remain widespread.
The economic reforms will also probably damage some Chinese businesses, at least in the short term. I’m thinking of utility and telecom companies that have benefitted from low input costs thanks to price controls. So there is plenty of risk here.
But over the long-term, these measures should boost economic growth. Granting more economic freedom to more Chinese citizens should encourage them to spend more. After all, if you’re confident that your property is yours and that you can benefit from any changes you make, you’ll be more likely to improve it.
So these reforms could help China achieve a smoother transition from an investment-led economy to one where consumption is more important. If China can pull off such a transition, I’m in no doubt that current Chinese share prices will prove to be cheap – even after the gains since Friday.
As I wrote last month, if you compare the value of China’s stock market with the country’s overall GDP, the stock market is only worth around 50% of the country’s GDP. The equivalent figure for the UK is around 130%.
What’s more, Shanghai’s Composite index is trading on a price/earnings ratio of 15, according to Bloomberg. That’s a pretty low rating for a country that has the potential to grow at 7% a year for the next decade. And the chances of that happening are now higher thanks to last week’s plenum.
How to invest in China
If you’re tempted to invest, I like the JP Morgan Chinese investment trust (LSE: JMC). It’s been running since 1993 and has performed pretty well since then. It trades at a 10% discount, so there isn’t too much scope to profit from a narrowing discount, but you could still make a good profit if the value of the trust’s assets rises over the next decade.
If you’d prefer to reduce your risk a little, you could diversify and invest across all emerging markets via funds such as the JP Morgan Emerging Markets Trust (LSE: JMG) or the Templeton Emerging Markets Trust (LSE: TEMIT).
Around 30% of the Templeton trust is invested in Hong Kong and China whereas the JP Morgan trust has a lower weighting in these countries at 18%. My mild preference is for the Templeton trust, as I’d like more exposure to China.
You shouldn’t go mad and bet the farm on China, but now could be a good time for a modest investment.
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