Foreign investors shorting Chinese shares are having a decidedly rough first couple of weeks of 2023.
A weeks-long rally is turning heads even as mainland data turns ugly in the short run. While all top-line economic data is ancient history by the time it’s released, China’s current series is as sepia-toned as they come, reflecting a pre-Covid-reopening era fast-losing market relevance.
As expected, indicators signaling a marked weakening of growth in 2022 before Chinese leader Xi Jinping changed course on Covid-19 lockdowns. Gross domestic product (GDP) expanded just 3% last year, the second slowest pace since 1970. That’s well below the roughly 5.5% Xi’s government wanted.
Yet for all the red ink, Xi’s economy has so far held up better than projected — perhaps adding new impetus for the China stock rally.
In December, retail sales contracted just 1.8% year-on-year versus expectations for a decline closer to 9%. Fixed-asset investment held up well at 5%, while the urban jobless rate fell to 5.5% from 5.7% in November. Industrial output rose 1.3% last month, bringing the gain for 2022 to 3.6%.
“The good news is that there are now signs of stabilization, as policy support doled out towards the end of 2022 is showing up in the relative resilience of infrastructure investment and credit growth,” says economist Louise Loo at Oxford Economics.
As China’s statistics bureau put it: “The foundation of the domestic economic recovery is not solid as the international situation is still complicated and severe while the domestic triple pressure of demand contraction, supply shock and weakening expectations is still looming.”
Stock investors are becoming more and more attuned to the economic climate that Xi’s pandemic U-turn is likely to produce in the second half, not today’s inclement financial weather.
“Zero Covid was brutal to economic health – it’s behind us,” says analyst Brian Tycangco at Stansberry Research. “What lies ahead is a reopened China” in this first quarter “and onwards.”
China has eased ‘zero-Covid’ rules in a dramatic policy u-turn. Photo: Screengrab / BBCAnalyst Craig Erlam at OANDA adds that “it’s tough to get a true gauge of the disruption the current [infection] wave is having on the economy but there’s no shortage of optimism for the rest of the year, particularly the second half. It could even come as early as the second quarter although that very much depends on how rapidly it spreads now.”
Economist Carlos Casanova at Union Bancaire Privée notes that “investors are keen to look past this fundamental shift, as they are focused on a consumption-led recovery that should take hold from the second quarter onwards. Compounded with a strong favorable base effect, we also envision upside risks to our above consensus 2023 GDP growth forecast of 5.2%.”
Hence investor optimism that China will end 2023 with more tailwinds than headlines for the second-biggest economy. This explains why overseas investors poured nearly $10 billion into Chinese shares in the first nine trading days of 2023.
“What’s going on in China looks like it’s not even a U-turn on Covid, it’s a V-turn on Covid,” says strategist Robert Buckland at Citi Investment Research.
Though Buckland says he’s taking a wait-and-see approach to China’s GDP trends, “that doesn’t mean we can’t have a kind of decent six months for China assets as we step away from China being completely uninvestable to being a troubled asset class.”
Yet it’s not just Xi’s about-face on Covid to which investors are responding. It also signals that the Communist Party is throttling back on moves to clamp down on the tech industry and private-sector development in general.
Since October, when Xi secured a norm-breaking third term at the 20th Party Congress, there have been clear signs that pessimism about Chinese equities had been peaking.
In the previous month, September, foreign investment in China dropped below the 4% of total market capitalization level. By late October, the CSI 300 index hit a 2022 low of 3541.33, a nearly 40% drop over 12 months until that point.
While the sudden pivot away from Covid lockdowns is the most important factor, so are signs in Beijing that economic reform is about to make a decisive comeback.
Some of the earliest hints Xi was rethinking Beijing’s crackdown on tech giants like Alibaba Group came during the summer from Vice Premier Liu He.
At the time, he reassured muskets that the party would “rectify” questions surrounding internet platform companies “as soon as possible” to stabilize the private sector.
The 20th Congress signaled that Xi was indeed serious about unshackling private industry. In December, the Central Economic Work Conference made it official.
The confab ended with a clearer commitment to increasing the development of the digital economy, reducing regulatory uncertainty and increasing the tech sector’s role in job creation and increasing Chinese productivity and competitiveness.
There’s optimism, too, that Xi’s preferred premier for his third term, Li Qiang, will have clout to recalibrate growth engines. Li would bring his experience from Zhejiang province, which is famed for free enterprise, to the halls of Beijing power.
Yet Xi’s work is only just beginning as China misses its annual GDP target. Other major growth drivers remain in trouble, including real estate. This is despite strenuous efforts by regulators to ease financing restrictions for homebuyers and developers. And moves by the People’s Bank of China (PBOC) to keep liquidity flowing.
Mainland home prices slid for a 16th month in December as Covid-related disruptions slammed an already weak property market. Sales of new homes across 70 cities – not including state-subsidized housing – fell 0.25% from a month earlier, a similar drop as in November.
“We believe it could take a few more months for property prices to show signs of recovery, due to Beijing’s determination on the zero-Covid strategy and its reluctance to stimulate home demand in large cities,” Nomura Holdings said in a January 16 report.
A worker at the construction site of Raffles City Chongqing in southwest China’s Chongqing Municipality. Photo: AFP / Wang ZhaoExports, meanwhile, are cratering. In December alone, overseas shipments plunged 9.9%, the worst performance since Covid-19 arrived in February 2020.
“This drop can be pinned on weakening global demand for Chinese goods, as well as some disruption to logistics networks and goods supply due to labor shortages amid the reopening wave of infections,” analysts at Capital Economics write in a report.
“The rapid fading of virus disruptions as China adapts to living with Covid-19, along with broader policy support, will drive a sharp recovery in domestic demand that will lift imports,” Capital Economics argues. However, “with growth outside of China still slowing, exports may continue to contract until the middle of the year.”
Covid risks abound, too. As the economy reopens, the upcoming Chinese New Year will see an explosion of travel in the most populous nation.
Many global investors doubt Beijing’s claims that Covid deaths during the most recent outbreak only number about 60,000. The question is the extent to which Xi’s government will tolerate surges in infection rates.
Analyst Zheng Xiaoxia at Huaan Securities thinks that “it’s likely the Covid spread has peaked ahead of schedule, and we look forward to a robust consumption recovery in services during the spring festival.”
It’s notable, though, that some of China’s top-performing macro hedge funds, including Shanghai Banxia Investment Management Center, worry there are limits to how quickly and dramatically consumer spending can recover.
“Consumption stocks are very likely to subsequently face a reality that falls short of expectations along with a stagnation and correction in share prices,” the firm founded by Li Bei argued in a January 8 report.
That’s why it’s up to Xi’s team to ensure it’s taking sufficient steps to stimulate the economy and push forward with reforms to validate today’s bullishness. The key, argues economist Hui Shan at Goldman Sachs, is maintaining accommodative fiscal policies in the first half of the year. After that, consumption and services likely “rebound sharply.”
Hui notes around East Asia, from South Korea to Taiwan to Hong Kong, consumption often drops early on as economies reopen from the Covid era. That’s followed by rebounds as fear fades. “We think Chinese growth is likely to display a similar pattern next year,” Hui notes.Despite today’s economic noise, more and more investors are betting Shanghai shares aren’t getting ahead of an expected improvement in economic fundamentals.
As strategist Laura Wang at Morgan Stanley concludes: “Signs of earlier macro bottoming out post Covid, committed stimulus policy, further currency strengthening, as well as near-term stabilization of geopolitical uncertainty should warrant greater allocation into China.”
Follow William Pesek on Twitter at @WilliamPesek