This article first appeared in Livewire Markets on 16 January 2023
Three years ago this month, the Chinese government imposed a lockdown in Wuhan and created travel restrictions for every city in the central province of Hubei. It was totally unprecedented at the time, but eventually, 'lockdown' became a word all of us became way too familiar with.
Now, after a period of mass unrest, Beijing is ready to reopen to the world. It also means the world's second-largest economy now has to go through what most other nations did in 2021 and 2022 - a period of increased outbreaks and decreased economic activity.
In this wire, I'll take you through the timing and the investing implications of China's reopening. We'll also get some insights from a slew of research as well as commentary from Casey McLean at Fidelity International, Andrew Clifford at Platinum Asset Management, and Diana Mousina, senior economist at AMP and permanent panellist of Livewire's Signal or Noise.
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Casey McLean, Diana Mousina, Andrew Clifford
Explaining the policy shift
On 27 December, the Xi Administration changed COVID-19's legal classification from “novel coronavirus pneumonia” to “novel coronavirus infection”, and in the process, downgraded the management of the disease in such a way that infected persons no longer need to be confined to facilities nor will a quarantine requirement exist for incoming travellers.
For Chinese citizens returning to our shores, the policy announcement said outbound travel will be “resumed in an orderly manner".
But that resumption is already coming with a few caveats, given Australia and 12 other nations have imposed travel restrictions - an announcement that was not viewed kindly by Beijing.
"We believe that the entry restrictions adopted by some countries targeting China lack scientific basis, and some excessive practices are even more unacceptable," Chinese foreign ministry spokesperson Mao Ning said recently.
What does this mean?
From an economic perspective, the views on whether this reopening could tip the global economy further into recession are split.
On one hand, manufacturing indices that measure economic activity at the ground level have fallen to their lowest levels since Q1 2020. Supply chain readings have also collapsed as firms are understaffed and firms continue to work out the logistics of what this reopening actually means for individual business operations.
Mizuho Bank's Vishnu Varathan sees things slightly differently. Given that production is depressed and the consumer is not spending, Beijing is likely going to step in with some form of stimulus to cushion the economic blow. But even stimulus payments, he argues, won't erase the "confidence deficit" caused by the lockdowns of the last three years.
So what does this all mean for Australia? Varathan argues the lucky country may find luck alone won't save our trade balance this time:
"The Federal Reserve's headwinds render commodity boost from China's re-opening [will be] shaky, if not hollow. Moreover, the RBA's tensions between sturdy jobs and housing risks could heighten risks of policy missteps hawks set to entrench. [It] looks like a bumpy commodity road out."
One person who will no doubt be hoping Varathan is wrong is Mark Tinker. Writing in Livewire last month, Tinker argued China's reopening has come at the right time for investors who spent all of 2022 more worried about inflation and central bank hikes instead of China's plans:
"Perhaps ironically, investors concerned over inflation should probably be thankful that the central government delayed re-opening as long as it did..."
But what about the bigger "R" word: Recession?
When we talk about the likelihood of a global recession, that usually pertains to a US-led recession simply because the US is still the world's largest economy in nominal terms. But China was in a recession long before the rest of the world, as Isaac Poole of Oreana Financial Services explains.
"The zero-COVID policy has done considerable damage to China’s economy through 2022. This is not a recession in the sense of two negative quarters of growth. This is a China-flavoured recession and we think it is closer to its ending than its beginning," Poole wrote recently.
Mousina believes China's reopening could gift the world a rebound in the second half of 2023 as consumption normalises and stimulus begins to kick in.
"We expect Chinese GDP to increase by 6% in 2023, after 2% in 2022 and above government targets and consensus estimates of around 5%. The strong rebound in GDP growth is likely to
push inflation up ... but inflation is unlikely to be a problem for China in 2023 which means that there is scope to ease monetary and/or fiscal policy if it is required," Mousina said.
McLean also believes policy settings will be pragmatically loosened. But whether the tiger economy can singlehandedly save a global recession is another matter. He says the recovery may not be smooth.
"We anticipate the recovery will not occur in a straight line, with growth acceleration more pronounced in the second half of 2023 and into 2024, meaning China alone is not likely to be enough to offset the slowdown in the other major economies," McLean said.
How can Australian investors take advantage of the reopening?
Mousina also believes there is an opportunity coming for Chinese equities. But she is wary of the other risks around in the market.
"In the short-term, Chinese shares have room to increase given the big sell-off in 2022 but there are longer-term geopolitical risks around investing in China, including risks in the tech sector from US trade controls," Mousina said.
UBS' Richard Schellbach has already done some work on this. Schellbach's number-crunching suggests there are 35 ASX stocks that could be considered "China plays". The average discount of these stocks (as of mid-December 2022) was 18% - more than the ASX 200 average discount of 17.3%.
But even this figure doesn't tell the whole story. Yes, it suggests a China reopening has not been priced into these stocks. But a closer look reveals that non-resource stocks are even more underpriced for the situation we are now seeing evolve. And that is where McLean is focusing his attention.
"Resources stocks have already rallied strongly as the noise of reopening was confirmed," McLean noted. "Whilst the link to commodities is clear, what is often under-appreciated is the exposure of consumer-related exports to China be it in areas like travel, education, infant milk formula (IMF) or vitamins," he added.
McLean says he's watching the ASX wine, travel, and education trades closely. Put another way, the focus will be on Chinese or ASX-exposed companies with "limited earnings risk and/or fully pricing in a downside scenario."
The other way to harness the Chinese reopening is, of course, to invest in Australian funds with exposure to Chinese equities. Clifford, who runs Platinum Asset Management's Asia Fund, sees the reopening of China as the bottom for the beleaguered stock market.
"Our view is that the impact of the lockdowns and COVID spread is already reflected in the Chinese market, with the SSE Composite Index down 15% in 2022. As long-term investors, we ... maintain our focus on China’s long-term economic rebound, which we think will be boosted by government policy support," Clifford wrote in a fund report recently.
Seven of the Asia Fund's top 10 individual stock positions are in either China or Taiwan. Some of the biggest weightings include world-famous names such as TSMC and tech giant Tencent. On the latter, Clifford was quick to praise its discount.
"Given investor scepticism about China, we were able to buy it at a discount to peers, and future growth prospects have been buoyed by this regulatory move," Clifford wrote.
