Why Better Times May Be Ahead For China’s Stock Market

by Regina Chi, Vice President & Portfolio Manager, AGF Investments

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% since early-May, according to Bloomberg, 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 if 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 significant and lasting 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 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% this fiscal year, according to Bloomberg, well below the government’s target of around 5.5%. That’s down 70 basis points from estimates at the start of 2022.

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 Beijing – or perhaps more importantly, local officials – follow through on implementing the more flexible COVID response, it would support projections for at least a partial normalization of supply chains and consumer mobility.

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 re-opening 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.

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 have 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 political strategist James Carville 30 years ago: “It’s the economy, stupid.”

 

 

 

 

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The views expressed in this blog 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.

The commentaries contained herein are provided as a general source of information based on information available as of July 8, 2022 and are not intended to be comprehensive investment advice applicable to the circumstances of the individual. Every effort has been made to ensure accuracy in these commentaries at the time of publication, however, accuracy cannot be guaranteed. Market conditions may change and AGF Investments accepts no responsibility for individual investment decisions arising from the use or reliance on the information contained here.

“Bloomberg®” is a service mark of Bloomberg Finance L.P. and its affiliates, including Bloomberg Index Services Limited (“BISL”) (collectively, “Bloomberg”) and has been licensed for use for certain purposes by AGF Management Limited and its subsidiaries. Bloomberg is not affiliated with AGF Management Limited or its subsidiaries, and Bloomberg does not approve, endorse, review or recommend any products of AGF Management Limited or its subsidiaries. Bloomberg does not guarantee the timeliness, accurateness, or completeness, of any data or information relating to any products of AGF Management Limited or its subsidiaries.

AGF Investments is a group of wholly owned subsidiaries of AGF Management Limited, a Canadian reporting issuer. The subsidiaries included in AGF Investments are AGF Investments Inc. (AGFI), AGF Investments America Inc. (AGFA), AGF Investments LLC (AGFUS) and AGF International Advisors Company Limited (AGFIA). AGFA and AGFUS are registered advisors in the U.S. AGFI is registered as a portfolio manager across Canadian securities commissions. AGFIA is regulated by the Central Bank of Ireland and registered with the Australian Securities & Investments Commission. The subsidiaries that form AGF Investments manage a variety of mandates comprised of equity, fixed income and balanced assets.

® The “AGF” logo is a registered trademark of AGF Management Limited and used under licence.

 

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