People walk past an electronic display showing the Hang Seng Index in the Central district of Hong Kong on May 27.BERTHA WANG/AFP/Getty Images
China stocks are slumping on news of rising COVID-19 cases in the world’s most populous country but that doesn’t negate their strong rebound in recent months. The MSCI China Index has still risen by more than 20 per cent since early May, when it hit what now appears to be a trough.
That is a remarkable recovery, given that the world’s second-largest economy has been challenged this year by COVID-19 flare-ups – including one that led to a lockdown of Shanghai, home to the world’s largest seaport, in the spring – as well as continuing global supply chain constrictions and uncertainty around Beijing’s regulatory crackdown on technology stocks. Only a few months ago, those factors led some Western market-watchers to openly wonder whether China had become “uninvestable.” So for those investors who rode out the downturn, the recent uptick in China stocks is surely welcome. The question, however, is whether the recovery is sustainable.
It very well could be, largely because of three developments. One is a subtle shift in the central government’s COVID-19 policy, despite fresh worries about new lockdowns being imminent. Another has to do with the gradual smoothing of supply chains as 2022 progresses. And finally, Beijing has begun to introduce meaningful economic stimulus, as well as policy reforms that could spark a recovery in consumption. Taken together, these trends may provide some tailwinds for China – and for China stocks.
China’s hard line on COVID-19 outbreaks is among the strictest in the world. The lockdown of Shanghai, which began on March 28 and lasted through much of May, provided an extreme example, and the application of “zero-COVID” policies there had an even greater impact on the Chinese and global economies than the quarantine of Wuhan back in January, 2020, when the pandemic was just getting started. Shanghai is not only China’s biggest city, with a population of about 25 million, but also an important shipping hub, and its factories produce key components of cars, mobile phones and other consumer goods. Not surprisingly, taking the city effectively offline for two months – along with an array of lockdowns, restrictions and stay-at-home orders in other Chinese cities earlier this year – has contributed to significant downgrades to estimates of economic growth. Current consensus is that China’s GDP growth will increase by 4.5 per cent this fiscal year, according to Bloomberg, well below the government’s target of around 5.5 per cent.
Yet a shift in China’s pandemic approach seems to be under way, and it followed quickly on the Shanghai debacle. Government officials have taken to talking up their policy as “dynamic” zero-COVID – emphasis on “dynamic.” The change in tone may signal more flexibility and adaptability in China’s COVID response, where the goal is less to eradicate infections than to control spread of the disease at minimal social and economic cost. Part of the strategy is more testing and adopting closed-loop systems – for instance, having employees live at factories and banks to keep operations running. Meanwhile, high-frequency COVID testing and pre-emptive, targeted lockdowns – of individual districts or facilities, for example – could reduce the likelihood of complete shutdowns of major cities.
If this pans out, the worst could be behind China in terms of macro shocks. Economic data from May confirmed that growth has bottomed, and a subpar recovery seems to be unfolding. Importantly, we expect supply chain disruptions to continue to ease throughout the summer, but recognize the potential risk of swelling COVID-19 case counts. This is especially true if a city like Shanghai ends up returning to lockdown only weeks after the previous one ended, yet draconian measures seem unlikely this time around.
Meanwhile, the macro policy response to China’s economic challenges earlier this year seems to be gaining traction. The government is spending heavily on infrastructure, which as the economy reopens should have a positive pass-through impact on housing and consumption. And in May, Beijing rolled out a broad package of measures to stabilize economic conditions, including enhanced tax refunds, deferment of social-security contributions, lower taxes on automobile purchases and more credit for small businesses.
While more must be done to support growth and boost consumer and business confidence, these moves are a good start, and the combination of reopening and stimulus should leave more cash in consumers’ pockets. That could create opportunities for investors. In particular, companies that produce and distribute baijiu – a traditional Chinese spirit that, in a country of 1.4 billion people, is also the world’s most consumed alcoholic beverage – could benefit from resurgent consumption. Two interesting names in this space are A-listed companies Kweichow Moutai (600519-Shanghai) and Wuliangye Yibin (000858-Shenzhen), both manufacturers of baijiu.
Given events of the past year or so, one could be forgiven for casting a skeptical eye at the recent recovery in China’s stock markets. After all, under President Xi Jinping, the central government has certainly surprised investors before. Yet a healthy skepticism should not mean ignoring clear signals. For one thing, the regulatory crackdown on internet companies that began last year – and rocked investor confidence in China – seems to be over or has at least paused. And government officials are talking a more market-friendly game. In a recent teleconference, they declared that “economic development is the basis and the key to solving all China’s conundrums” – a remarkable statement that they clearly intended to boost market confidence. If they mean it, Beijing might finally be recognizing a reality famously expressed by U.S. political strategist James Carville 30 years ago: “It’s the economy, stupid.”
AGF owns stock in both Kweichow Moutai Co. Ltd. and Wuliangye Yibin Co. Ltd.
Regina Chi is a vice-president and portfolio manager at AGF Investments Inc.
The views expressed are those of the author and do not necessarily represent the opinions of AGF, its subsidiaries or any of its affiliated companies, funds or investment strategies. References to specific securities should not be considered as investment advice or recommendations