- Category: Financial Fundamentals
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The plenum discussed arcane ideological issues but the real takeaway for investors is that government policy is the real mover of markets and sometimes a better predictor of profit or loss than company fundamentals or even changes in the economy.
But the message of the plenum is lost amid media noise and Wall Street static. The theme of fazhi has been translated loosely - and misleadingly in my view - as rule of law. The English expression, as understood in open democracies, refers to governance under which the law is the ultimate authority - not the government or the Party or the President or any person or institution.
Such an interpretation of the plenum is unwarranted. The leadership discussed the importance of being law-abiding. But it is a huge leap to conclude that the Party has accepted that that no one, including itself, is above the law. A statement issued after yesterday's meeting made it clear: "China will work to build a law-abiding government, and will ensure the leadership of the Communist Party of China in the socialist rule of law with Chinese characteristics".
What the Party has accepted is that it must deliver more than a full stomach to win hearts and minds in 21st century China. In convicting princeling Bo Xilai of corruption two years ago, it cited for the first time the need to "safeguard ... the rule of law" because it was a "significant guarantee for realizing the nations long-term stability".
How and why crime moves markets in China
Misinterpreting signals in China's opaque political world puts the investor at risk of making decisions on the basis of information that is skewed and sometimes even downright wrong.
Consider the market impact of the anti-corruption drive, which is too often presented by the media as a heavy-handed crackdown on crime. But the campaign is not about police work. It is central to President Xi Jinping's broader efforts to restore the credibility and ruling legitimacy of the Party. To underestimate the political will behind his campaign is to underestimate the impact it can have on businesses.
Share prices tell the story. They are almost always first to be hit as political gossip in China travels quicker than the speed of light.
Under siege by investor panic is Chinese developer Agile Property Holdings. Its share price has been taking a pounding since two of its directors came to the attention of the nation's graft busters. The cash-strapped developer had to reduce a previously planned $213 million rights issue amid conflicting rumours of the investigation. One company director is reportedly in detention while another is helping investigators with their enquiries.
The smart money, so the chatter goes, is more worried about which executives might have ties to the disgraced former security chief Zhou Yongkang (who was among nine men then at the apex of Party power and who is now helping police with enquiries) than with the $2.1 billion company's financial fundamentals and its ability to repay a $475 million offshore loan maturing in December.
Illiquid one day, insolvent the next
The next domino to go is typically credit access. One day the company is illiquid, the next day it is insolvent.
Huatong Road and Bridge Group, a little-known construction company in the northern province of Shanxi, averted a last-minute default on a $65 million loan last year after the local government stumped up the cash. Problems had begun when news broke that its chief executive was assisting in a corruption investigation.
The typical industry response when a company's chief executive lands in this kind of hot water is for bankers to stop issuing short-term credit lines and for suppliers to withhold credit altogether. Had a rescue not taken place, Huatong would have made history in the nation's first corporate default.
Any break in credit lines is the death knell for companies reliant on short-term funding to stay afloat, which is just about everybody in the construction and property sectors where markets have been softening and revenues from new projects stagnating.
Received wisdom in the domestic market is that faulty government policy can remain in force for longer than an investor can stay liquid - as those who had bet against Beijing's crackdown on the then red-hot property market in April 2010 later discovered to their pain.
As the chart shows, the crackdown on property prices had very little impact on the real market for 18 months. The average selling price of property in 10 major cities remained buoyant. Cash flow of property developers was healthy. Local governments relied on the sector's income for revenue. The fundamentals at the time were all against dumping property shares.
Chinas property market
Chart: Sofun, Asia-analytica
But A-share market investors knew better than to bet against policy. Five years on, Beijing is signalling that perhaps it cracked down too hard on the sector. But that is of little comfort for those who had put their money where it would have made sense in a conventional market responsive to supply and demand.
The message from this week's Party conclave is clear: Ideology is back in the driving seat. In terms of investment, fundamentals matter only when they do not go against broader policy direction.
- Edited by Robert Ryan
Pauline Loong is managing director of Asia-analytica Research and senior fellow of the CIMB ASEAN Research Institute
Important notice: Nothing in this report is intended to be, or should be construed as, an offer to buy or sell, or invitation to subscribe for any securities or as advice relating to legal, technical or investment matters. This report has been prepared on the basis of information that is believed to be correct and from sources believed to be reliable. Asia-analytica makes no express or implied warranty as to the accuracy or completeness of any such information and makes no undertaking to update any such information. Opinions expressed are subject to change without notice.