This was underscored by official December data released over the New Year's long weekend. The manufacturing PMI fell to 47 in December from 48 in November, while the non-manufacturing PMI declined to 41.6 from 46.7 in November. The services sub-segment dropped to 39.4 from 45.1.
While business sentiment is likely to remain volatile, we believe the government’s latest steps to downgrade COVID protocols and remove quarantine controls for inbound travelers from 8 January confirm our view that growth is now being prioritized over other objectives. This means a full reopening is likely to play out in 1Q23, auguring well for the medium-term investment outlook.
The economy may suffer a deeper, but shorter setback. In our base case (80%) we expect a bumpy Chinese reopening with a definitive end to broader and longer lockdowns, centralized quarantines, and mass testing in the first quarter. This is likely to result in peak infections in the major cities within weeks. Minor temporary curbs, like dining restrictions, may return as local authorities try to flatten the infection curve. But unlike in the past, it is now the spread of COVID infections, rather than curbs, that is impacting businesses as people stay home to recover. The government’s hurried change in messaging may also leave some members of the public hesitant to resume pre-COVID behaviors for some time.
We think the economic damage from the initial COVID shock will be concentrated in the fourth quarter of 2022 and the first quarter of 2023. Both consumption and production are likely to suffer as infections surge—with activity already deteriorating more than expected in November (retail sales –5.9% y/y).
Beijing appears to be opting for a “big bang” style exit from zero-COVID—one where the infection peak is passed as soon as possible—versus the staged process we had earlier envisaged. Case numbers are likely to stabilize after the Lunar New Year holiday, and we think a recovery in consumption and activity will begin as early as February, picking up pace from 2Q onward. Beijing’s supportive stance and pent-up savings should provide an additional boost—to around 5% consumption growth in 2023, while a faster return to social activities could lead to more upside in 1H23. We continue to expect GDP to recover to around 5% growth in 2023.
Favor reopening winners in equities over the next six-12 months. Given the quicker-than-expected reopening, we think select companies in the consumer, internet, pharmaceutical and medical equipment, transportation and capital goods, and material sectors are likely to see more frontloaded returns. We recommend investors focus on these winners rather than the broader market, targeting a 15% outperformance against the wider MSCI China index over the next six to 12 months. Although broader Chinese equities may also see percentage upside in the teens through end-2023, the less orderly reopening means that near-term progress will likely be choppy, with risks of earnings downgrades as the initial economic toll of the COVID spread is felt.
Property developer bonds, oil, and yuan to benefit too. We think that China’s reopening is also a positive for Asian IG and HY bonds, in particular Chinese property developers. A quicker recovery in consumer confidence should fuel a faster stabilization in property demand, while the increased availability of onshore funding also reduces the default risk for quality state and private developers. Other reopening sectors, such as Macau gaming, also stand to benefit. While we don’t expect a repeat of the performance in November for the Asia HY benchmark (+14%), we think the positive momentum will continue with a total return of 7–10% in 2023.
For commodities, we expect crude oil to emerge a winner from China’s reopening. China is the world’s second largest oil consumer, and we expect two-thirds of oil demand growth to come from emerging Asia in 2023. In FX, we expect the CNY to appreciate and there is potential for our end September target of 6.7 to be reached earlier—in 1Q or 2Q—thanks to the faster-than-expected reopening.
So, as China's reopening gathers momentum, we shift our focus from “when” to “how” it will take place. In summary, we think select reopening beneficiaries could offer double-digit outperformance over Chinese equities in the next 6–12 months. In credit, IG bonds remain attractive while Asia HY bonds could post 7–10% total returns next year. Oil and the CNY should also receive a boost from China’s faster reopening.
Main contributors - Mark Haefele, Min Lan Tan, Patricia Lui, Vincent Heaney, Jon Gordon
Content is a product of the Chief Investment Office (CIO).
Original report - Taking stock of China’s rapid reopening, 3 January 2023.