China had an interesting announcement after the close of trading last night which entails opening up the mainland securities markets to Hong Kong investors. According to regulators, China National Radio reports the government is going to trial quota issuance to Hong Kong securities firms for mainland investment. Securities brokerages and fund management firms will be able to use Yuan proceeds raised in Hong Kong to invest in domestic securities markets. China is approving 20 billion Yuan for the initial trial of quota which will be investible up to 80% in fixed income markets and 20% in equity markets. There isn’t much information out at this stage, but opening the domestic market up to a wider array of investors is the first step towards opening the market in general. The process of opening markets in China will happen slowly and steady over time, at the pace Chinese government officials desire. Steps in the right direction are important because they will help attract capital inflows. The timing of the announcement is worth taking note of. My suspicion is that many initiatives get pulled together and shelved only to be announced when they are of use for meeting particular policy objectives. The A-Share markets in Shanghai and Shenzen have been in a tremendous bear market and the government is looking for ways to improve confidence and support the economy. More market friendly initiatives for the domestic China market would be very important for the health of global equity markets in general.

The A-Share markets in China are watched closely even though they are a captive market. For the most part, mainland Chinese investors have no ability to invest outside the domestic A-Share China markets and the rest of the world has no ability to invest in China’s mainland securities markets. The A-Shares are viewed as both a momentum based and policy driven market. Last weekend in Barron’s, Chris Wood of CLSA, called the A-Shares the most policy driven market in the world. He is looking for the A-Shares to catch up to the performance of Hong Kong based markets in order to believe that easing measures are being implemented in earnest. Last night, the A-Shares and the H-Shares were both up 2%.

China has moved sharply back into investor focus and may end up being the “tipping point” market for global markets in 2012. The slowdown in economic activity out of Europe is contributing to a reduction in Chinese GDP growth as Europe is China’s largest collective export market. The Chinese PMI has decelerated in November and there is anecdotal evidence of a slowdown in exports, machinery, and industrial demand. China has started the process of monetary policy easing by reducing reserve requirements but is only doing so tepidly. Credit growth and real estate prices have been reined in by the government and are important areas where easing is likely to take place in early 2012. Overnight, markets in China had their first meaningful rally in two-weeks. Moreover, the currency which has been gravitating towards the weaker end of the currency peg appreciated by 70 basis points verse the dollar last night. With the US economy performing solidly and Europe heading towards recession, the economic environment in China may tip the scales for the global economy.

If the US and China are both strong in 2012, it will be much easier to not focus on Europe, every day, all the time, for another year. If both Europe and China are exhibiting much weaker growth in 2012 relative to 2011, it will create another treacherous investment environment next year. Hopefully some of the speculation of policy easing and announcements of market friendly initiatives by the government provide hope that China can soft land, and the world can be on solid footing. Fingers crossed for 2012.

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