Now could be the moment to buy back into China

It has been a torrid year for Chinese equities. While the Chinese themselves have been floating above the economic recession their shares have been dire underperformers.

The Shanghai index has fallen some 32% and is now back down to the level it traded in April 2009.

Yet Fidelity's Anthony Bolton - who having moved to Hong Kong has been immediately installed as Britain's leading investor in Chinese shares - is now arguing that the second leg of the equity bull market is coming and that China is likely to lead it.

Buy China?

So is now the moment to buy back into China? Its one of the toughest investment calls out there at the moment. Some leading fund managers like First State Investments' Angus Tulloch has never been more cautiously positioned on China. He argues that inflation is a real problem that will prove almost impossible to fully stop. Presumably by inference in order to stop it monetary tightening will be needed on a scale that the Chinese equity markets cannot hope to navigate serenely.

Tulloch said: ‘We are still very cautious. Rates are artificially low and inflation is the genie in the bottle. What’s happening in Asia is the beginning of that. Wages in the developing world are going up 15% to 20%. When you have manufacturers pushing up prices like that it is going to have a huge effect.’

Indeed monetary tightening itself must be the primary culprit for the underperformance of China over the past year. Beijing has fought hard to stamp on a potential bubble in the property market, tightening bank lending more generally and begun allowing the currency to gradually appreciate again.

Caution

Yet as Sinophiles never tire of telling us we should be cautious about seeing the Chinese story just in simple liquidity terms. Unlike Western nations there is in Beijing a government determined to chart a course of strong economic growth which has all the possible tools at its disposal to do this.

While we have been worrying about monetary tightening, the Chinese government has under the surface been pressing ahead with a number of reforms which must ultimately be good for Chinese shares.

It has pressed ahead with the initial public offering of the Bank of Agriculture. Yes this paves the way for more monetary tightening but it is also further evidence of the fact that while the Chinese have watched with smug grins as the de-regulated West has beaten itself into an economic pulp they have not abandoned their own de-regulatory drive.

De-regulation is key

For GaveKal analyst James Barnes this is the key factor to focus on with Chinese equities at the moment.

'The main force behind China's bear market has not been excessive valuation, nor has it been a pronounced growth slowdown. Instead, the main culprit has clearly been the removal of excessive liquidity, with the government visibly attempting to squeeze and consolidate property developers, and pushing banks to raise capital.

'But amidst all the negative news headlines, investors may be overlooking what remains for us one of the most important changes underpinning China's future growth story, namely deregulation in China's financial sector'.