Shanghai Composite

HONG KONG (CNNMoney)

For much of 2012, the Shanghai Composite was one of the world's worst-performing indices, seemingly destined to end the year in negative territory.

But favorable economic reports and the prospect of market reform has drawn investors back in this month, driving the index into positive territory for the year and 16% above its early December low.


As recently as Dec. 3, the index was down 9% on the year. At the same point, the Nikkei was up more than 10%, the FTSE 100 was up 3%, and Germany's DAX had skyrocketed 22%. In the United States, the S&P 500 had more than doubled from its recession lows, jumping 10% since January.
But China's marquee index has mounted a robust rally over the past month, helped by strong manufacturing, industrial and trade data. On Monday, HSBC's manufacturing PMI index, a key indicator, hit its highest level in 19 months in December. And last week, Beijing reported industrial profits were up more than 20% year over year.
Buoyed by the reports, the Shanghai Composite closed the year at 2,269 points on Monday, up 3% since January.
China's economy is still expanding at an annual rate of 7% to 8%, but it has slowed somewhat from figures that often exceeded 10% before the global financial crisis.
The slowing pace of growth -- still the envy of many nations -- has weighed on stocks. For much of 2012, listed companies reported lackluster profits while retail investors abandoned stocks in favor of higher returns on alternative investments, especially physical property, wealth management and trust products.
Related: Chinese firms go on U.S. spending spree
But the latest round of data seems to have encouraged investors. The index's rebound has also been fueled by hints at greater regulatory reform -- especially signals from policymakers that more foreign investment will be allowed.
"Foreign investors are becoming more sanguine on the A-share market, while domestic investor sentiment appears to be finally bottoming," equity analysts at HSBC wrote in a recent report.


The HSBC analysts, who are bullish on the Shanghai Composite's performance, predict that improving economic conditions, coupled with rising risk appetite, positive fund flows and structural reforms, should lead to higher returns in 2013.
Still, stumbling blocks remain, and the detailed intentions of China's new leadership are not widely known.
"The second wave of reform is set to be considerably more difficult and internally-focused than the first, as the government strives to better align government and markets through further price reform, stimulate demand through new-style urbanization, improve income distribution and enhance supply discipline by breaking up state monopolies," HSBC's analysts wrote

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