Will China's New Leadership Usher Bull Run for Stocks?

China's battered stock markets may finally have something to cheer about – a once-in-a-decade leadership change.

Will China's New Leadership Usher Bull Run for Stocks?
Stephen Shaver | AFP | Getty Images

Starting November 8, China begins a months-long process that will culminate in the world's second largest economy getting a new set of leaders, which China bulls believe will bring momentum back into the equity markets that have been in a downtrend since 2009.

The 18th National Congress of the Communist Party of China (CPC) in November marks the start of the leadership transition in the mainland. The National Congress is a platform to unveil new policies and announce key appointments in the Party.

"This is the most important event in China in the last decade or more, it is more important than the (Beijing) Olympics. You can't imagine a better trigger for Chinese sentiment than the inspiration of new leaders giving speeches, parades - a major emotional driver," said Aaron Boesky, CEO of Marco Polo Pure Asset Management in Hong Kong.

He added that "when Chinese domestic investors get excited - 99 percent of them are reading the same Xinhua news releases - they can drive the index hard and swift in one direction."

The direction of Chinese stocks is largely determined by the country's retail investors, who account for almost 80 percent of turnover at the Shanghai and Shenzhen stock exchanges.

The positive momentum created in the run-up to the final leadership handover in March 2013, when the new leaders take charge, and an acceleration in growth in the fourth quarter will be the "two forces" to drive the stock market beyond the 3,000 mark next year, or 45 percent higher from current levels, according to Boesky.

He added that while a turnaround in the stock markets will start in November, big gains will arise in the second quarter of 2013 after the transition is completed.

(Read More: China Stocks a Screaming Buy: Strategist)

Steven Sun, head of China equity strategy at HSBC, agrees the two catalysts of growth stabilization and the handover of power will drive a rebound in the market.

While China's gross domestic product growth fell to its lowest level in three and a half years in the third quarter, experts think the economy has bottomed out and growth will accelerate from the fourth quarter onwards.

"A rebound (in stock markets) is possible as growth stabilizes and the transition of power goes smoothly," Sun said, adding that leadership reshuffles have typically had a positive impact on investment activities and credit growth.

China's stock market reaction following the last leadership transition in November 2002 would suggest such as event does little to lift sentiment, but analysts said it is an inappropriate base for comparison as there were many external factors influencing the direction of global equities including the September 11 terrorist attacks in the U.S. and the dot-com bubble burst in the preceding year.

Cautious Optimism

Not all China watchers, however, think a leadership reshuffle will do much for Shanghai stocks.

While the installation of a new leadership will remove an element of uncertainty it will not be a major catalyst for the market in the near-term, according to Howhow Zhang, research director at Z-Ben Advisors, a Shanghai-based investment management consultancy.

"Policymakers don't usually come out with major initiatives until three to six months after the transition," Zhang said, adding that polices of the new leadership will likely be very similar to that of the current government.

"In six to 12 months, you will see a market that's gradually improving, but nothing excessive," Zhang added.

According to analysts the next round of policymakers will continue to focus on rebalancing China's economic growth and reforming the financial and social welfare systems - many of these objectives were already laid out in the 12th five year plan released in 2011.

(Read More: China Cabinet Seeks Ambitious Economic Reform Agenda)

Mark Matthews, head of research Asia at Bank Julius Baer, added the two men poised to become China's new president and premier - Xi Jinping and Li Keqiang - are both "moderates" and will likely lack the power or determination to make tough decisions.

"They don't look like the type of people who are going to launch big stimulus, they are more worried about the widening social divide," he said.

Don't Expect a Big Stimulus

The other reason the new leadership is unlikely to embark on any aggressive stimulus - fiscal or monetary – is because latest economic indicators out of the mainland indicate the worst is likely over, said experts.

The latest purchasing managers index (PMI) published by the government, for example, showed manufacturing activity ticked up in October.

(Read More: Why Market Euphoria Over China PMI Data Might be Overdone)

"Anyone who expects anything dramatic at this point is looking in the wrong direction, aggressive monetary easing would reignite property market speculation and in any case, there is no particular need for an aggressive approach," said Uwe Parpart, managing director and head of research at Reorient Financial Markets.

Boesky of Marco Polo Pure Asset Management, however, disagrees, forecasting that policymakers will loosen monetary policy beyond most expectations in the first year, in order to demonstrate their commitment to stabilizing economic growth.

"China has plenty of ammunition left, they hiked rates five times (over 2010-2011). The outgoing regime is setting it up so the incoming guys can be the heroes. They will be stocked up with a six percent lending rate and will have major room to run in their first year," he said.

(Read More: Will China's Next Move Be a Rate Hike?)

China's official lending rate stands at 6 percent, significantly higher than that of other major economies including the U.S., Japan and Europe, whose interest rates have remained near zero.

Beyond Politics

Looking beyond the leadership transition period, some strategists including Geoff Lewis, global market strategist, at JP Morgan Asset Management say politics will not play a central role in determining the success of Chinese stocks in the coming months.

"China could be one of the better performing markets over the next 12 months, but I wouldn't put it down to euphoria over what the new leadership will say," Lewis said.

He added that his positive outlook for mainland stocks is tied to the market's attractive valuations, and easing worries over falling profits as the earnings downgrade cycle comes to an end.

The Shanghai Composite is trading at a price-to-earnings ratio of about 10, the cheapest since 2008.

"As economic data begin to support the scenario of a soft landing, that will help to change sentiment and end the long underperformance of Chinese stocks," he added.