Last updated: 10:32 / Tuesday, 17 December 2013
By Henderson Global Investors

The Third Plenum

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The Third Plenum

The Chinese government recently released details of the reforms announced at the Third Plenum and the market has reacted positively. The Plenum is a key meeting of top Communist Party leaders to discuss China’s future policy direction. At the center of the policy changes are reforms addressing the government’s role in the economy and business, and the introduction of more market-orientated mechanisms to guide the development of industries.

While the reforms will have varying implications for different industries, the reduction in the role of the state alone could spark a drop in the risk premium applied to the Chinese market where indices are dominated by mega cap state-owned enterprises (SOE) trading at low price-to-earnings and price-to-book value multiples. The Plenum also addressed critical reform agendas that will improve the prospects for social stability and the rise of consumption, such as relaxing the one child policy, increasing rural ownership and land use rights for farmers and those owning agricultural land, and changes to the ‘hukou’ system of urban social welfare entitlements, all of which can help rebalance the Chinese economy over the long term.

We believe that market sentiment will be lifted by the announced reforms as investors witness the improving quality of economic growth and evolution of the financial and real estate sectors as well as fiscal policy and pension systems. A re-rating of Chinese equity markets is also likely, with the Hang Seng China Enterprises H Shares Index currently looking cheap on a forward P/E ratio of less than 9x – see chart 1.

Chart 1: Is a Chinese re-rating overdue?

Source: Datastream, Hang Seng China Enterprises H Shares Index, price earnings ratio, monthly data, 31 October 2003 to 31 October 2013.

The Chinese economy has continued its cyclical expansion with rising economic growth and industrial activity. Rising growth appears to be the result of government policy augmented by strengthening recoveries in Japan, Europe and the US. Clearer policy direction has certainly come from the Third Party Plenum. We believe there is sufficient scepticism over the Chinese story to allow ongoing positive surprises for some months. Stock picking should add value in this environment. We see abundant growth and value opportunities at present. Consumption stocks tend to be somewhat more expensive, but continue to offer high growth rates in earnings. Meanwhile, large state-owned enterprises (e.g. CNOOC) appear remarkably good value and valuations imply very negative outcomes, which we do not believe will occur.

Opinion column by Charlie Awdry, Investment Manager, China Opportunities Strategy, Henderson Global Investors.

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