GLOBAL

Place your bets now that China will push for a rally as a huge political shift takes place November 8. Whether it can fix a struggling economy is another question, writes MoneyShow's Jim Jubak, also of Jubak's Picks.

Maybe Spain will formally request a bond-buying program from the European Central Bank in the next few days, setting off a global stock market rally. But my bet on a macro trend to drive global stock prices over the next four to six weeks would be on China.

The Communist Party finally announced a date—November 8—for the 18th party congress that will formally transfer power to Xi Jinping and a new (or "newish" anyway) group of leaders for the next ten years.

Investors have been waiting, increasingly tensely, for the party meeting date. Each day that passed without an announcement raised fears that the transition would be tumultuous. So there was a small but still audible sigh of relief on Friday, when the schedule was finally set.               

The odds are good that investors will drive the prices of Chinese stocks higher as soon as the National Day Golden Week holiday, which began Monday (with an estimated 85 million Chinese hitting the road), ends.

Last week, stocks in Shanghai started to rally on speculation that the government would use the holiday period (when the stock market is closed) to announce new stimulus measures and new rules to encourage stock buying. Let's handicap the odds that Chinese markets will see that rally continue after the holiday.

2 Reasons for a Rally
First, valuations on the Shanghai market are extremely low. The Shanghai Composite Index is valued at 10.3 times estimated earnings. That compares with the S&P 500, which trades at 14.19 times projected earnings, 12.6 times projected earnings for the London FTSE-100 and 35.68 times projected earnings for Tokyo's Nikkei-225.

Now, there's absolutely no reason a cheap market can't get cheaper, but the Chinese media have been full of statements like this lately: "History shows that a low market valuation tends to be followed by a considerable rebound," Liu Ti, the director of the Financial Innovation Laboratory at the Shanghai Stock Exchange, said last week. The laboratory also reported that blue chips (however defined) in Shanghai are trading at the lowest level in history.

Second, continued bad economic news has heightened speculation that the government and the People's Bank will move more forcefully—sooner rather than later—so that the new leadership team will take over an economy that is showing accelerating growth.

From this perspective, the just-released report that the manufacturing sector contracted in September—for a second straight month—is actually good.

The Purchasing Managers' Index was below 50, indicating a contraction, marking the first two-month decline since 2009, a survey for the National Bureau of Statistics and the China Federation of Logistics and Purchasing indicated. This increases pressure for government measures to reverse a stubborn economic slowdown.

The index came in at 49.8 in September. That was better than the 49.2 reading in August, but it still indicated the economy was contracting. And it was below the 50.1 median forecast from economists surveyed by Bloomberg.

From this point of view, even bad economic and financial news from Europe (unless it turns deeply scary) can be seen as a plus, since slower growth in China's biggest export market will goad Chinese officials and regulators into earlier action.

On this kind of thinking, Shanghai stocks rose 1.45% on Friday and gained 2.96% for the week. That gave the index a 1.91% gain for the month to snap a retreat of four consecutive months.

Betting on the Government
You'll notice that all this is about sentiment, and attempts to read the tea leaves to predict what twists and turns that sentiment is apt to take. Certainly, investors can't yet see any fundamental improvement in the Chinese economy that would lead to higher earnings, supporting Shanghai stocks at higher prices.

In fact, what we can tell of upcoming third-quarter earnings argues that large swaths of the Chinese economy will report falling profits, if not outright losses. Already, leading Chinese companies such as Baidu (BIDU) and critical Chinese sectors such as the steel industry have guided stock analysts to expect hard times.

But stock markets look ahead, so it wouldn't be unusual if the Shanghai market were looking past a rocky third quarter and anticipating a better fourth quarter.

In addition, the Shanghai market also normally moves on attempts to predict changes in government policy. Traders in that market frequently buy and sell in an effort to profit from shifts in government policy and the timing of those shifts. In that context, a rally here wouldn't be unusual.

Do you want to put some money into a potential rally built on speculation about sentiment, built on the crowd's anticipation of a change in government policy? If I put it that way, your answer is almost certainly no.

But how about if I argue this way: The Shanghai Composite Index is down 70% from its all-time high in October 2007, and down more than 40% from its post-financial crisis high in August 2009. The index is trading at the same level as in mid-2001. The stock market of one of the world's fastest-growing economies has gone nowhere in a decade. Isn't it ready for a period of outperformance?

Especially if China and other emerging stock markets reestablish the kind of anti-correlation to developed markets that they've shown for a good part of recent history—until the European debt crisis, in fact. From a long-term point of view, the recent period where Chinese stocks tanked when European stocks stumbled has been the exception and not the rule.

If China can reaccelerate its rate of economic growth, aren't investors looking at a return to a period of anti-correlation, when problems in developed stock markets are met with a period of outperformance for Chinese stocks?

Tickers Mentioned: Tickers: BIDU, CCOZY, HKXCY, JIXAY, SNYYF