Market Views: How investors can tap China’s reopening
China is dropping its zero-Covid policy - and the world is watching eagerly. Stock markets were the first to respond with a strong rebound in November. Analysts say this could bring back investors’ attention to China and consequently, invigorate equities across the region.
Vice-premier Sun Chunlan, who leads the central government’s Covid policies, dropped the reference to zero-Covid for the first time in three years in a meeting with the National Health Commission on December 1, after Chinese residents’ anger over zero-Covid peaked with large-scale protests across the country in late November. That signalled a major shift away from China's relentless lockdowns and testing campaigns.
The government in early November had already started to loosen some of its stringent Covid restrictions as well as offer more support to property developers.
Investor optimism over signs of China's reopening led Hong Kong-listed Chinese equities’ to their best month in two decades. In November, the Hang Seng Index jumped by 26.6%, and the Tech Index soared by 33.2%.
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On Wednesday (December 7), the State Council announced 10 new Covid easing policies, including allowing home quarantine for asymptomatic or mild cases. That is another policy milestone, indicating the country is gearing up to live with the disease.
AsianInvestor asked strategists what opportunies and risks investors should look out for when the world’s second-largest economy finally starts to move away from Covid-19 restrictions.
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The following contributions have been edited for clarity and brevity.
Bill Maldonado, chief investment officer
As China moves towards reopening its economy in 2023, the potential upside is attractive, given that we believe we are past the worst in terms of impact for investors, and with valuations, earnings expectations, and investor positioning at extremely low levels.
We expect growth to bottom out in the first quarter of 2023 as the government fine-tunes its Covid policy and provides more supportive measures for the property sector.
A full reopening would probably take place around the first half of 2023, and GDP growth is likely to rebound to 4-5% in 2023.
That said, any disruptions of China’s reopening in the first half of 2023 or a sudden rise in inflation as a result of pent-up demand would be key risks to look out for in China.
Chinese policymakers are likely to keep monetary policy accommodative, which would be supportive for bonds. Within Chinese equities, we believe that there are alpha opportunities in sectors that are aligned with China’s strategic goals as well as in sectors that will benefit from China’s structural growth trends. This may include high-end manufacturing, new energy, healthcare, semiconductors, renewables, hospitality, and smart infrastructure.
Local government financing vehicles (LGFVs) will continue to play a key role in supporting the economy as infrastructure will be an important growth driver in the near term. As for property, we continue to favour state-owned developers over private developers.
However, with time needed for homebuyers’ confidence to return despite the ‘16-point plan’ [rescue package], we believe it is unlikely to see a turnaround in property fundamentals until late 2023.
Among other sectors, in the near term, services, industrials, and materials sectors are likely to benefit from reopening and recovery.
Carol Lye, associate portfolio manager & senior research analyst
China’s soft reopening came fairly quickly. We had been expecting some sort of relaxation of rules to happen after the Party Congress meeting but with a full reopening in the spring of 2023.
We had been positioned with risk on currency trades, especially in Asia, for example, the Korean won and Thai baht.
In the fixed income space, we have avoided Chinese government bonds. We have also been increasing our exposure to emerging market high-yield sovereign bonds.
At this juncture however, the market has quickly priced in the good news of reopening. Asian investment grade credit bond spreads have mostly re-normalised. With the government support given to Chinese property developers, spreads have collapsed rapidly as well but are still somewhat wide compared to history.
From here, there will be bumps in the road to reopening as caseloads rise and hospitals may not be able to cope, leading to some tightening in rules again. Whether the economy can reopen more fully with international borders reopened depends on vaccination rates for the elderly, which we are watching closely.
Nonetheless, as we continue to move towards a full reopening, we see opportunity for the Asian currency markets to continue rallying.
Emerging market high-yield sovereign bonds will also continue to benefit from the dual tailwinds of domestic emerging market inflation coming off and a more positive external environment via China’s reopening and a dovish Fed.
A backup in yields will also provide opportunities in the China investment grade technology, media, and telecom space and selected Chinese property bonds.
Ben Bennett, head of investment strategy and research
Legal & General Investment Management
Chinese assets have continued to rally hard as officials lift some Covid restrictions. However, restrictions remain harsh compared to much of the world, and we think they will have a negative impact on growth in the coming months.
Rather, the market reaction has been a function of sentiment switching from very negative to now being hopeful of a reopening later in 2023.
Cheap valuations after a very weak 2022 for Chinese equities and offshore property developer bonds also played a significant part in the move. Now that positioning and sentiment are more balanced, investors will want to see if hope turns to reality.
One scenario is that infections rise rapidly, impacting hospital capacity and necessitating a return to harsh lockdowns. I think investors would be disappointed by such an outcome, and we would see much of the recent rally reverse.
The more optimistic scenario is that infections remain under control during the winter months, allowing a more aggressive lifting of restrictions in the spring.
Under such a measured scenario, outperformance could switch from deeply discounted sectors like property and tech to areas of the economy that will benefit from a return to normality – the in-person service sector, travel, entertainment etc.
But even if the rally continues, it’s likely to be far less fierce than the initial move. And Chinese policymakers will need to be careful to avoid the capacity constraints that have impacted reopening Western economies, with inflation soaring, central banks hiking and bond yields climbing, ultimately undermining equity valuations.
Tai Hui, APAC chief market strategist
JP Morgan Asset Management
A more optimised way to manage Covid policy in China in the coming months should improve the outlook of the domestic job market as well as consumer and business confidence.
We expect the Chinese economy to be on a recovery path in 2023, contrasting with the US and European economies, which are facing recession headwinds amid high inflation and high interest rates.
We have already seen a number of e-commerce giants benefitting from this news. They have adjusted their business models in the past two years to comply with the new regulatory environment, as well as managed costs more effectively to protect their profit margins. An improvement in spending would boost their revenue.
Beyond that, consumer discretionary should also enjoy fresh momentum with pent-up demand being released in 2023.
In addition, if China regains its growth momentum, it will also bring more positive catalysts to Asia markets overall as improving Chinese consumer spending partially offsets softness in Asia exports to the west, and returning Chinese tourists create growth momentum for the service and tourism sector in the region.
Anthony Wong, senior portfolio manager
Allianz Global Investors
The opening up is likely to be bumpy. Different local governments will interpret the “optimised” strategy in different ways.
The beneficiaries of reopening have been leading the equity markets – online travel portals, duty-free store operators, restaurants, airlines and so on.
The other area of strength has been property. The CSI Real Estate Index (i.e., listed China A-share developers) rallied by 31% in November and – remarkably given the environment – is almost flat year to date (local currency).
The catalyst has been a decisive shift in policy following the Party Congress to ease the funding pressures of cash-strapped developers. The China securities regulator joined in last week by lifting a multi-year ban on equity raising by A-share and HK-listed H-share property companies.
We interpret this as more of a risk management exercise, with the main purpose being to facilitate the completion of already pre-sold homes – we still view property as a sector in gradual but structural decline, especially given demographic changes.
But nonetheless, by easing the acute financial stress and starting the process of rebuilding confidence (as well as homes), this also removes one of the obstacles to a macro recovery.
In summary, we see recent policy news as meaningfully increasing the probability that 2023 will see an acceleration of economic growth.
This will feed through into corporate earnings, especially in the second half of next year.
Against a backdrop of reasonable absolute and relative valuations (MSCI China 10.4x, MSCI China A Onshore 12.0x forward PE as of November 30), we see reasons to be more optimistic on the return outlook for China equities in the year ahead.