China's stock market regained its status as the global growth leader in November, thanks to massive economic reforms proposed by the government.
For the month, China mutual funds returned 4.4% vs. 0.9% for the average world equity fund, according to Morningstar. Emerging market funds on average lost 1.6%.Global X China Financials ETF ( CHIX ) was the top-performing China region ETF, jumping 6.88%.
Investors are snatching low valuations while betting that China's government will do whatever it takes to stay in power by pleasing the people with steady economic growth.
The proposed reforms aim to transform the world's second-largest economy from dependency on exports and government infrastructure spending to being driven by consumer spending. With five dozen proposed measures, the reforms include giving foreign investors more market access, providing more financing for fast-growing private companies, raising the dividend payout on state-owned enterprises and relaxing the one-child policy.
All of the policies are aimed at ensuring stability, says John Rutledge, chief investment strategist at Safanad, an investment firm in New York. He privately advised about half the people who drafted the reform package.
"Long-term political and economic stability is the only thing they care about," he said in an email. "Stability means avoiding political disruption so that growth can compound over many decades and bring China's living standards to Western levels. Stability also means that any changes to party rule will be gradual, increasing the chances the leaders can stay in power."
Shares of infant formula and other baby-product producers, and even tutoring companies, soared in reaction to the easing of the one-child policy. Couples are now allowed to have two children if one of the parents is an only child. Every year, about 16 million babies are born and 15 million passenger cars are sold, yet only 500,000 child car seats have ever been purchased, presenting colossal potential in an underpenetrated market, said Eric Brock, co-manager of Clough China . And products that used to be luxuries -- milk, infant car seats and baby strollers -- become staples as living standards improve and more people enjoy middle-class lifestyles.
Deutsche Bank forecasts the MSCI China index will appreciate 20% to 25% over the next 12 months, thanks to the reform measures and a cyclical recovery in 2014 with 8.6% gross domestic product growth. They expect economists to raise their GDP growth forecasts for the next three to four years by at least 0.5%, which would translate to an additional 3% in earnings growth.
Sentiment Seen Improving
"We expect market sentiment to be significantly lifted, as investors will gradually understand the increase in China's growth potential as well as the improving sustainability of economic growth and stability of the financial, real estate, fiscal, and pension systems due to reforms," Deutsche Bank wrote in a special report Nov. 18. DB gave bearish ratings to coal, copper and steel producers because of new antipollution measures.
IShares MSCI China ( MCHI ) trades at a bargain price-to-earnings ratio of 10, price-to-book value of 1.25 and price-to-sales of 1. It's much cheaper than the MSCI Emerging Markets index trading at a P/E of nearly 12, P/B of 1.4 and P/S of 1.
The bears, on the other hand, doubt that China can enforce new policies. There will be strong opposition to reforms by those prospering from the way things are. They could take years to implement.