Kyle Wales, Portfolio Manager at Flagship Asset Management
China’s abandonment of its zero-Covid policy is a positive economic development both for China and for the rest of the world. It is no surprise then, that the Hang Seng Index is up 15% versus a flat MSCI ACWI since December 7, 2022, the day of the de facto end to this policy .
However, while the short-term financial market response may be ebullient, it doesn’t mean investor concerns will, or should, go away any time soon.
The lifting of zero-Covid does little to atone for the negative impacts the policy had on the quality of life of Chinese citizens or their economy. Many suffered as their personal freedoms were taken away. Then the policy’s rapid withdrawal, rather than a patient considered policy reversal, has resulted in a greater number of covid deaths than would have otherwise been the case.
The Chinese were not the only economic casualty of zero-Covid; foreign investors were similarly harmed. Zero-Covid is just one in a long line of decisions taken at the top echelon of the Chinese government that has negatively affected investors and this has played out in deeply negative investment returns.
The first of China’s missteps was its poor approach to regulation. China’s regulatory problems began in 2020 when, in quick succession, the IPO of Ant (a subsidiary of Alibaba) was abandoned due to Jack Ma’s criticism of China’s regulators, China’s for-profit education sector was regulated out of existence with the single stroke of a pen and the investment value of the New York IPO’ed Didi (a ride hailing company) was impaired to zero after it was forced to delist. As a result, the Hang Seng fell 20% from the beginning of 2020, while the MSCI ACWI moved sideways. Within this context, the recent market strength is merely a blip on the radar screen.
The second development that spooked investors was the emergence of Xi Jinping as a political strongman. His securing an unprecedented third term as general secretary of the Chinese communist party was viewed negatively globally because it further concentrates power in the hands of a single individual. This adds to the unpredictability of the Chinese government’s decision-making. Definite parallels can be drawn with Russia and Turkey, with both those economies sliding after their leaders expanded their mandates to rule and heralded political repression.
Thirdly, aggressive political rhetoric is not helping China’s economic prospects – or the way investors view the country as an investment opportunity. There is no doubt that China’s manufacturing sector will get a boost from returning factory workers and its services sector will get a boost from the resumption of tourism; however, there are other factors at play. China’s manufacturing sector has not only been weak due to its zero-Covid policy but also due to weak demand from the West. Some of this weakness is due to slowing growth, but it is also a result of political issues.
China’s hostile approach to the West has already meant one of its largest investors (Apple) is steadily moving manufacturing to less-hostile locations like Vietnam and India. This trend will continue. Government’s erratic policymaking has contributed to other Western companies reassessing their dependence on China in their supply chains. Any short-term recovery also needs to be placed in context of the longer-term damage that has been done over the last couple of years.
China is sufficiently large that, for many foreign investors, it is simply too big to be ignored. However, recent years, have seen the rewriting of the rules of the game. As a result, a large part of the discount that investors are currently applying to Chinese assets should remain to account for geopolitical risk) and the percentage of their portfolios that they are prepared to allocate to China should be smaller, recent strength in Chinese assets notwithstanding.
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