What will the Year of the Rabbit bring for investors in China?
Investor sentiment towards China has dramatically improved following the government’s u-turn on its zero Covid policy. What does the shift mean for the country’s economy and markets?
Chinese New Year in January 2023 ushered in the Year of the Rabbit. Legend has it that the rabbit was particularly proud of his speed and agility. Events of the past few months suggest that the Chinese government has discovered its own inner rabbit, having scrapped nearly all of its draconian Covid restrictions far faster than anyone anticipated.
The prospect of a rapid economic recovery has led to a 40% rally in the MSCI China Index since the end of October1. While the index has now recovered to the level it was at in the summer of 2022, it is still around a third lower than its peak in early 20211. This suggests there is the potential for further gains.
Timeline: Regulation, Housing, Geopolitics and Covid
Source: Cazenove Capital
The changing tide
Last November, protests against China’s zero Covid policy quickly escalated. While local protests are not uncommon, the scale of these demonstrations was almost unprecedented. There were two key catalysts. First, a fire that killed 10 people in an apartment building. Firefighters were unable to reach the building in time due to physical restrictions put in place to enforce lockdowns. Second, the 2022 World Cup and the sight of thousands of fans enjoying the event without Covid restrictions. Social media became a hotbed of discontent and Chinese media reportedly censored footage of crowds at matches, even digitally adding masks to fans’ faces.
Within weeks, the government began to remove restrictions and continued to do so through December. This culminated in the opening of China’s international borders, allowing travel in and out of the country for the first time in three years. This has provided a huge boost to tourism-related sectors, such as Macau’s casinos.
It's not all good news, however, as the rapid re-opening has caused a surge in Covid infections. Much of the population is still unvaccinated and, as a result of low levels of infection to date, natural immunity is low. As expected, the medical system is now under huge pressure.
More encouragingly, there are some signs that infections may have already peaked and the “exit wave” will be short and sharp. There is a risk of lockdowns returning, as we saw in second waves in developed markets. However, the government’s priority is on growth rather than virus control and this looks unlikely.
Who is set to benefit?
China’s agenda for 2023 is focused on one thing: growth. At least, that seems to have been the main message from the Central Economic Work Conference, held in December. Support for the ailing property market is on the table, with the sector’s stability regarded as key to managing wider economic risks. Policymakers have indicated that they will support "high-quality” property developers. There is even talk of easing the “Three Red Lines” policy that caused much of the property-market disruption in 2021/22. This should mean China’s real estate market will be the one of the main drivers of economic growth this year - and possibly market returns.
China to drive global growth in 2023
Source: Schroders, December 2022
As China moves past its Covid exit wave, we should see consumer confidence and spending rise, providing a boost to consumer-facing sectors – such as retail and hospitality. We expect to see significant pent-up demand for services and entertainment, with the potential for “revenge spending” – consumers spending far more than they normally would as a result of the enforced isolation of the past three years. Spending will be boosted by savings accumulated during lockdown, as we saw in Western economies. European luxury goods manufacturers stand to benefit. Brands such as Hermes and LVMH remain popular in China, with the majority of products still bought in person rather than online. Re-opening should therefore drive sales.
The travel sector could also see further gains. Real-time mobility data has shown a recovery in activity – but not yet to the pre-Covid levels. This is likely to take more time, as we saw in Europe and the US.
With the Chinese government focused on infrastructure and improved energy security, we could also see commodities perform well. In the near term, OPEC is forecasting an increase of half a million barrels of daily oil imports to China which should support energy prices. Longer term, the transition to renewable energy (which remains one of our key secular themes) will see increasing demand for industrial metals such as copper and lithium. China continues to account for around 50% of all commodity imports globally, so a reopening of the economy could be supportive for the asset class.
Boost to Chinese markets and global growth
The rapid reopening of China’s economy is positive for markets, with analysts upgrading earnings expectations across multiple industries. There are still risks for investors in China, including property companies’ high levels of debt, Covid and tensions with Taiwan and the US. However, the near-term outlook is clearly better than was expected. This could well drive further gains in local assets as well as stronger-than-forecast global economic growth.
1 Data from 31st October to 20th January. GBP denominated and total return