China: Happy Year Of The Horse?

(Drivebycuriosity) - Today the Chinese celebrate New Year, the begin of the "year of the horse". Last year, the "year of the snake", delivered mixed results: China`s economy grew 7.7%, the same rate as in 2012, but the Shanghai Composite Index, a gauge for Chinese stocks, lost 11%. What can you expect from a snake? Maybe the "horse", which stands for speed, will be more investor friendly.

In spite of annual growth rates of 7% plus Chinese stocks are in a bear market: From its peak of around 3,400 points in summer 2009 the Shanghai Composite had been falling around 40% to around 2,000 points through the end of 2012. Since then the index has been glued to the 2,000 mark.

It seems that Chinese stocks are trapped in a pessimism bubble. Investors are obsessed with the negative aspects and are blind for the ongoing strength of the broad economy. For years China bears like New York Times correspondent Paul Krugman and Jim Chanos, a hedge fund manager and notorious short seller, have been banging the "China crash drum"  (driveby). The China crash callers claim that China is suffering from huge structural problems like too high debts and too huge investments into real estate which would cause a "hard landing" of the Chinese economy.

This view is strongly biased as the annual growth rates of 7% plus show. China is rapidly transforming into a consumer economy like  the U.S. and other modern countries. Many peasants are moving to the huge metropolitan centers which are spread all over the huge country to lift their standard of living. This creates a fast rising affluent middle class, giving consumer spending a boost as the strong retail sales (growth rates 13% plus) demonstrate.

Last year Beijing announced a new economical reform to bolster China`s transformation. "The Economist" calls the announcements the most wide-ranging and reform-tinged proposals for economic and social change in many years (driveby). According to Bloomberg the announced changes are aimed at giving more influence to market forces and loosening government controls.

The reforms include:

- an end of the strictly one-child-only policy which should reactivate China`s slacking population growth, giving consumer spending a boost
- allowing farmers to sell their communally owned land at market prices  which - according to the bank Société Générale - will boost farmers’ income, thus providing them with the start-up capital to settle in the city
- permitting private investments in state-owned companies which should make them more efficient

The country will be still controlled by the communist party which will keep her monopolistic political power. But citizens and entrepreneurs gain more economical freedom. This means less Mao Zedong, who had enforced the strict control over everything by the communist party, and more market economy in the spirit of Adam Smith, Friedrich Hayek and Milton Friedman, who called for the "freedom of choice".

The reforms should bolster consumer spending and stabilize the economic growth in the range of 7%. China also could get some tailwinds from the advancing global economy. Especially the recovery of battered Europe should rekindle China`s exports.

All 3 factors: consumer spending, reforms & exports could work together amplifying each other. 

History shows that any bubble has to burst sometime. Maybe the "year of the horse" is the time when the China pessimism bubble pops and the stock market recovers.