Written by: Regina Chi, CFA® | AGF
In an article last July about China, we anticipated that Beijing would moderate its harsh zero-COVID policy into “dynamic zero-COVID,” creating a methodical and careful path to full economic reopening sometime in the first quarter of 2023. Well, that prediction was wrong, or at least half-wrong: throughout the rest of the summer and into autumn, Chinese authorities doubled down on zero-COVID – nothing “dynamic” about it – locking down cities whenever outbreaks occurred.
But then, everything changed. In late November, citizens across China took to the streets to protest Beijing’s draconian measures; some even took the extraordinary risk of calling for President Xi Jinping’s resignation. The discontent embodied by the so-called “whitepaper protests” was so widespread and so vocal that the government was forced to respond. By Dec. 7, it had begun to loosen COVID restrictions; by Jan. 8, it had lifted them altogether. So, that July article turned out to be half-right: China did reopen in Q1 2023 – just not at all in the way we had imagined.
Obviously, forecasting geopolitical trends is not an exact science, especially when it comes to China – the recent downing of a suspected spy balloon over the U.S. providing a case in point. But no one can question the clarity of China’s pivot on COVID policy. The sudden reopening, with vaccination rates still low, has resulted in a chaotic surge of infections and deaths, slowing the economy and creating public discontents of its own. Meanwhile, however, the reaction in financial markets has been much more buoyant. In the first 10 months of 2022, the China MSCI Index declined by more than 40%, but since the reopening began it has rebounded by over 50%, according to Bloomberg data. If, as investors apparently expect, China can navigate its current challenges and get its economy rolling again, it will have a significant positive impact not just on the world’s second largest economy, but also on emerging markets as an asset class. China is that big – and it’s reopening may be that big a deal for EM investors.
One reason for optimism is that China has not simply reversed its effort to contain and control COVID-19, but is also opening up on policy more broadly. Last December, the ruling Communist Party’s Central Economic Work Conference pledged more business-friendly policies, according to Reuters. The regulatory crackdown on big tech, including the “rectification” of Internet companies, has already waned, and the government has signalled more support for the property sector and its financing needs. As the recent war of words over “Balloongate” shows, geopolitical tensions remain a risk, but there have been some signs that China wishes to avoid outright conflict with the West. In short, China’s pivot on COVID-19 appears to be part of a wider, pragmatic move away from some of its most market-antagonizing policies of the past couple years.
Arguably, the most important factor to watch is consumer spending. Hyper-restrictive COVID policies crushed consumption in China, leading to a massive expansion of household savings, which increased by a RMB$2.6 trillion last year alone. Those accumulating deposits amount to as much as RMB$17 trillion, or about 10% of GDP, which would translate into huge purchasing power if Chinese consumers choose to spend it – and that’s the trillion-dollar-plus question. If they do, then China’s reopening is set to release massive pent-up demand for travel and services by consumers who have been in lockdown for much of the past three years. That positions consumption as the main engine for GDP growth in 2023, which is expected to come in at 5.1% versus 3% in 2022, per Bloomberg. (By comparison, U.S. GDP is expected to be 1% in 2023, according to J.P. Morgan.) We could well see a fuller economic recovery as a result of China’s quick policy shift as early as the second quarter.
The impacts of China’s sudden reopening, however, will be felt beyond its borders. Emerging market headwinds are turning into tailwinds. Remember: China comprises nearly 34% of the MSCI Emerging Markets Index, and its reopening should drag other economies into higher growth mode. After three years in the doldrums, Chinese and stocks in other EMs are under-owned, in our view. Declines in EM corporate earnings have already set in and should run their course by Q1, while earnings in the rest of the world are still too high (and have nowhere to go but down). The U.S. dollar has already begun to fall, and when the U.S. Federal Reserve begins to cut rates sometime in 2024, as is widely expected, it will fall even further. Emerging markets equities tend to do very well when the U.S. dollar is weak.
Which countries could benefit the most? Those with strong export ties to China – Taiwan, South Korea and Southeast Asia markets, in particular. As well, commodity producers should fare well on resurgent demand from China and a weakening U.S. dollar. India, which was a safe haven for EM investors throughout 2022, could end up a source of cash to fund China’s expansion.
The point is, China is such a dominating presence on the emerging markets landscape that if it outperforms, then emerging markets outperform. With its 180-degree turn on COVID and other policies, the world’s second largest economy is setting the stage for a broad-based rally. No prediction is 100%, of course, but 2023 might well be remembered not only as the year China reopened, but also as the beginning of a new bull market in EM.
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