China is on the right path filled with challenges

UBS Securities published its latest A-share strategy report "18th Third Plenary Session communiqué – on the right path filled with challenges". Below please find the highlights:

Reforms are on the right path: The communiqué highlighted the role of the market; specifically, it changed the market’s "fundamental role" to a "decisive role" in resource allocation. The communiqué mentioned that "economic reform is the focus for comprehensive deepening of reforms" and the "core issue is dealing with the relationship between the government and the market", reflecting the determination to deepen the reforms. A communiqué covered most of the hot topics discussed in the market, e.g., the relationship between the market and the government, mixed ownership, fiscal system, farmers’ property rights, free trade zones, and judicial system reform. We believe the communiqué is in line with market expectations for reforms, and the reforms are on the right path.

Looking forward to more policy details: The communiqué only covered simple reform proposals. It will take some time before more policy details are announced. For example, the specific definition of "devoting major efforts to developing a mixed ownership system" requires further policy discussion. The communiqué did not mention some issues expected by the market, such as financial system reform, local debt, real estate taxes, household registration, and relaxation of rules on second children for parents who were single kids. It is still difficult to establish whether or not these issues will be included in the details later. Fortunately, the market has not had very high policy expectations. The performance of the market has reflected investors’ policy expectations for the Third Plenary Session. We observed that policy-related theme-based sectors have undergone relatively more significant corrections since October.

Neutral to slightly positive overall impact on the market: We believe the impact of the communiqué on the market will be neutral to slightly positive. Just like the market consensus, a communiqué is just a highly condensed summary. Policy details need follow-up confirmation, and many of the reforms may encounter difficulties during implementation. The market needs to wait a while longer.

Investment themes: We believe land reform, free trade zones, national security, and state-owned enterprises may become long-lasting investment themes. Household registration reform, population policy, and financial reform remain to be seen, and may have a short-term negative impact on related thematic investment in terms of sentiment. The communiqué did not specifically discuss the real estate market. We believe the absence of policy is the best policy here, so the real estate sector is likely to see a valuation re-rating.