No. Despite the recent spate of lockdowns in China, we still anticipate some form of easing of the current zero-COVID policy and increased support for the economy following the Party Congress in October. This will ultimately drive a rebound in the Chinese economy and allow Chinese equities to outperform global equities. While the timing and extent of the policy change are uncertain, low valuations for Chinese equities give us comfort that the potential upside provides compensation for bearing the current uncertainty.
Over the past three weeks, a series of COVID-19 outbreaks has led at least 70 cities in China to impose lockdown measures, impacting an estimated 300 million people. Prolonged lockdowns and drought-related hydroelectric energy shortages will further hit an economy that grew only 0.4% year-over-year in the second quarter due to lockdowns in Shanghai and Beijing and a slowing property sector.
Given the challenging economic backdrop, the upcoming Party Congress on October 16 takes on even more importance. While it is widely expected that Xi Jinping will secure a third term as the leader of the Party (and thereby China), the Party Congress will also unveil the other members of the Politburo and lay out the general policy direction for the next five years. This will help alleviate the current political and policy inertia in China, given lower-level officials (and business leaders) will have more clarity on power dynamics and any changes in priorities.
There are grounds for cautious optimism that some changes are afoot. First, the date of the Party Congress itself was moved forward from November to October, suggesting the leadership understands the urgent need to provide more clarity. Second, Xi Jinping and other government officials will be traveling outside of China in September and November. The fact that Xi is travelling ahead of the Party Congress shows his confidence in his domestic political standing. It may also be a subtle signal that engagement with the rest of the world is now important, which could imply further relaxation in COVID-related travel restrictions. Hong Kong has already shortened the quarantine period to three days, and there are expectations of further reductions this year. Third, the government has already announced several support measures for the property sector, including a roughly $150 billion funding plan to help healthy developers take over uncompleted projects of stressed developers.
Still, what matters most for the economy is any shift in the zero-COVID policy. While China has been effective at containing the spread of the virus and limiting COVID-related deaths, the economic costs are mounting. Consumer confidence has collapsed to record lows, and urban youth unemployment is at a record high of 20%. Frequent lockdowns, even if short in duration, create a sense of uncertainty for households and businesses that hold back spending and investment. Thus, it is hard to see a meaningful economic recovery without some form of policy shift on COVID-19.
It remains to be seen when this shift will occur. Our sense is that announcements following the Party Congress will set the stage for an eventual shift, considering the dire state of the economy. However, meaningful change in policy may not occur until first quarter 2023, given the required tilt in government rhetoric and because major policies are formally approved and adopted at the National People’s Congress, which is typically held in March. Other analysts warn that the shift may not take place until China has developed its own mRNA vaccines or other treatment breakthroughs that make the leadership more confident that China’s healthcare system can handle any surge in COVID-related hospitalizations, suggesting a policy shift won’t occur until much later in 2023.
Due to the current uncertainty, Chinese equities are like a coiled spring, waiting for the downward pressure to be lifted. Because valuations for Chinese equities are currently depressed, we think investors are compensated for the heightened uncertainty, especially since markets could react quickly and powerfully to any change in zero-COVID policy, making it very difficult for investors to time this pivot.
Furthermore, a recovery in the Chinese economy in 2023 could see Chinese equities outperform global markets amid a monetary policy–induced slowdown in the United States and Europe next year. China is not facing the same inflation pressures seen globally (headline inflation is running at 2.5%), given the depressed state of the economy. This gives China scope to further increase fiscal and monetary stimulus, while the rest of the world grapples with rising interest rates. This divergence in economic cycles adds another layer of optionality and diversification that Chinese equities bring to global portfolios.