Downturn in China a matter of Hu and Wen

Xi and Li set to take stage, need to shine in 2013 and 2014

Think of sequential quarterly earnings reports and the pressure these put on senior executives to continually outperform the past, and then multiply that pressure by 10,000 times. Got it? That is China in transition to its 5th Generation of leaders, Xi and Li.

Consider avoiding commodity and resource funds for at least next six months

Expectations and economic performance are both down in 2012, and global investors should look for this trend to continue for at least another half year. Why? With the new leaders being appointed this October and taking full power in early 2013, this is an ideal time for a down year in China. The growth target is 7.5%, the lowest in years, but it may actually turn out to be a year of negative growth, for two main reasons.

One: Xi and Li will want to have decent year-over-year numbers, at least from mid-2013 and on, so between now and the end of the year, the current "lame duck" administration will be given plenty of incentives to let things slide, so that any rebound and turnaround can be credited to the next leaders. The legacy of the 4th Generation has already been firmly established, so a few months of sliding numbers will not tarnish their massive accomplishments.

Two: Commodity prices; any shoring up of the Chinese economy in the near-term will boost commodity prices, whereas it will be far more beneficial for Xi and Li if commodities happen to drop precipitously over the next year.

Summary: If you believe that China will loosen credit significantly in the coming weeks to avoid a severe downturn, keep an eye out for cosmetic moves that make it appear the government is dealing head-on with the situation, when in reality they will likely be conspiring to slow the rate of decline, but not the decline itself. That work will begin around November to February.