Chinese government reforms loom

Another night of solid north prints, the S&P clocked up its seventh consecutive northward print and the ASX made a five-year closing high yesterday.

Australian consumer confident has shot off post the federal election, business confidence is in the same boat while business conditions have a little ways to go to catch up to the herd. These leading sentiment numbers could be trumped today by the unemployment rate which has an estimated rise of 10 basis points from 5.7% to 5.8%, and may take a bit of the heat out of the AUD, having had its best week since December 2011.

The AUD is in an interesting bind at the moment; Asia is well and truly back on investors’ radar, Japan is growing and India and Indonesia have plugged the holes of capital outflows as investors repatriate funds back to developed nations from developing ones.

This leaves China as one to watch for the AUD and the ASX; it has just entered a bull market with the Shanghai Composite up 21.4% from the low on June 25 - credit is flowing fast. The aggregate finance for the month of August hit RMB1.57 trillion (US$256 billion) which was 65% higher than estimates. Exports are flying having gained 7.2% in August and industrial production at 10.4% is the highest reading in over a year.

This suggests that China is currently insulating themselves from effects of tapering by attracting fund inflows into the country while most other developing nations see net outflows. Premier Li’s pledge to hit 7.5% GDP growth year-on-year looks set to be achieved and the restriction of fund outflows will migrate any kind of mass repatriation that would stall the current growth recovery. The Chinese dragon does look like it is set to take off once more, which explains the AUD’s current rise.

However, yesterday’s speech by Premier Li to the World Economic Forum suggests that China still has some major economic hurdles to clear before the newly installed government can rest easy. ‘The foundation of an economic recovery [in China] is not solid yet, with many uncertain factors’ with ‘An important part [for a stronger] economic-system being financial reform’. We have already seen what Premier Li is looking to achieve here; the cash squeeze in the middle of the year amplified the May to June slide on the Shanghai Composite, the ASX and other region markets and the wringing out of speculative lending will continue to occur periodically over the coming years.

In the same speech he did reiterate his commitment to 7.5% GDP growth in 2013 with a 7% growth target in the coming years. China will lay out the blue print to economic reform in a meeting in November when Chinese leaders meet for their economic forum. The meeting will address the results of the local government credit audit as the central government looks to address local government debt and reduce the possibility of a Chinese-styled GFC, something ‘people are all concerned about’ according to Li. At the same meeting it is expected that the government will outline its pledge to push forward with interest rate and exchange rate reforms.

Expect undulates (positive and negative) across the region in the lead up to this meeting as the market looks to pre-emptive measures. We see these reforms as a very positive step for longer term trade abilities with the country. It is looking to grow sustainably with a credit system that is better managed and sustainable. The move towards a ‘slightly’ less pegged yuan is also positive as it will naturally regulate inflation and consumer spending - all very positive economic reforms.

However, implementing these reforms will create blips; credit spikes, cash crunches and industrial slowdowns are going to occur over the coming year, and will present trading opportunity.      

Ahead of the open we are calling the ASX 200 up six points to 5240 (0.11%). We are climbing the wall-of-worry pretty well at the moment, however there is a feeling that when we hit the year-to-date high of 5249.6 the market will be at a cross roads. With the Fed looking at tapering next week and the German elections, the weekend after flash points are coming and increased volatility is certain. We are due for a pullback after such a strong run; it would be healthy and give the market a chance to reset for a final push into Christmas.

BHP’s ADR is suggesting the stock will lose five cents on the open to $36.28 and may drag on the rest of the material sector today. The positive call may follow the cyclical sector in the afternoon if the unemployment numbers are weaker.

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