Why markets mustn’t overread the tea leaves on China’s Covid protests and reopening

Even before the Covid protests, a shift in Beijing’s pandemic management had become the most talked-about issue in markets
Divining Beijing’s intentions is a fool’s errand. Even investors can’t agree on which scenario poses more of a threat to asset prices: imposing more lockdowns or allowing the virus to spread more easily

Nicholas Spiro

Published: 3:45pm, 1 Dec 2022

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Shortly after the Covid-19 pandemic erupted in March 2020, many investment strategists became amateur epidemiologists, producing reams of research on the virus – some of it highly technical – in the hope of determining the level of disruption and its implications for different sectors of the economy and asset prices.

Never mind that modelling the evolution of the pathogen posed enough of a challenge for experienced virologists, and that traders misjudged the economic fallout – particularly the severity of the inflation shock – as well as the speed and scale of the recovery in markets. The fear of missing out on a profitable trade and the need to explain and justify moves in markets led investors to speculate intensely about a subject they knew little about.

Over the past few weeks, and especially in the last several days, many international investors have tried to pass themselves off as China experts. Even before last weekend’s protests across the country against the government’s draconian “zero-Covid” controls, a shift in Beijing’s pandemic management had become the most talked-about issue in markets, although investors differed sharply on its significance.

However, the demonstrations, which pose a significant challenge to China’s Communist Party, have broadened the scope of market speculation about the political calculations of President Xi Jinping, particularly how he intends to respond to the social unrest and the potential damage to his regime.

While it is not surprising that many international investors believe insufficient attention has been paid to China – the zero-Covid policy does not even figure in the top “tail risks”, according to Bank of America’s monthly global fund manager survey – markets are notoriously poor judges of political risk.

Foreign investors are particularly ill-equipped to assess and price risk in an opaque and difficult-to-read market like China, and even more out of their depth when it comes to predicting how Beijing’s pandemic management will play out.

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The uncertainty and unpredictability that pervade the reopening of China’s economy stem mainly from the fact that the government’s policy choices are deeply at odds with each other. The political, public health, social and economic considerations involve extremely tough trade-offs Beijing is only starting to come to grips with, making investors even more dependent on signals and adjustments to policy that are often misconstrued or overinterpreted.

Since the government’s decision on November 11 to ease some of its stringent Covid-19 controls, sentiment towards China has become more volatile and fickle. Having clamoured for an earlier reopening, markets are now more circumspect in a sign that investors themselves are uncomfortable with the trade-offs facing Beijing.

Tellingly, in a report published on Sunday, Goldman Sachs warned of the risk of a “disorderly” exit from the restrictions as the government comes under pressure to reopen the economy sooner than anticipated, due to pent-up frustration at the disruption caused by its zero-tolerance approach.

In 2023, manage expectations of a Fed pivot and China’s reopening

This shows that investors are not just unsure how and when China will reopen, they are not even certain which scenario poses more of a threat to growth and asset prices: imposing more lockdowns or allowing the virus to spread more easily.

The reality is that divining Xi’s intentions is a mug’s game. Nomura, one of the more astute observers of China’s management of the pandemic, noted in a report published on Wednesday: “Markets are swamped by rumours, WeChat screenshots and tweets full of cherry-picking messages.”

Nomura also drew attention to steps taken this week by the local government in Guangzhou – China’s third largest city that has been battling a surge in infections – to relax curbs in accordance with the recent guidance from Beijing. One of the measures announced by Guangzhou’s health commission was boosting vaccination rates among the elderly.

The real test of China’s willingness and ability to reopen is the efficacy of its vaccine drive aimed at plugging the vast gap in natural immunity. With less than 70 per cent of the over-60s and only 40 per cent of the over-80s having received booster shots, and home-grown mRNA vaccines still undergoing clinical trials, the underpinnings of the “China reopening” trade look even shakier.

China’s economic reform provides a blueprint for its exit from zero-Covid

Markets have enough problems determining the path of US monetary policy, particularly whether the Federal Reserve will be forced to start cutting interest rates next year if the United States economy slides into recession.

Indeed, one of the factors that has encouraged some foreign investors to turn more positive on China is the perception that the global economic backdrop has become more benign, mainly due to hints from Fed policymakers that the pace of rate hikes will slow but also because of signs that Europe’s energy crisis has abated.

However, investors were wrong about inflation this year and may again be off the mark in 2023 if, as seems likely, prices do not fall fast enough. If markets are not even getting the big calls right, betting on China’s unpredictable reopening is a fool’s errand.

Nicholas Spiro is a partner at Lauressa Advisory