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Commentary

China 180

December 19, 2022

Summary

  • Emerging markets bounced back throughout the month, fuelled by signals that inflation is peaking, China announcing measures to support the property market along with taking steps to reopen.
  • More cyclical markets such as Brazil and the Gulf states underperformed, as recession risks for major economies loom.
  • The DXY dollar index retreated, providing an additional tailwind for EM. 

Portfolio Activity

  • Added to China H-shares, particularly names set to benefit from a recovery in consumer demand as COVID-zero is phased out.

China’s Policy Pivot

While CCP Congress drew focus to longer term structural risks brought about by Xi’s consolidation of power and confirmation of a third term, the event was followed by a series of policy announcements that addressed more immediate economic and political risks, that served as a positive catalyst for Chinese equities.

Property

  • Beijing announced one of the first major support measures for the property market in an attempt to put a floor under structural risks in the sector.
  • The measures inject around US $183 billion of credit into the property sector (Jeffries estimate) and should help to alleviate the wider economic drag brought about by the crunch.
  • Likely a turning point with additional policy support to follow to ensure the recovery in home sales and credit growth has legs.

Has Beijing ditched ‘wolf warrior’ diplomacy?

  • Beijing’s diplomatic charm offensive began with German Chancellor Olaf Scholtz leading a high level business delegation to meet with Xi and Li Keqiang. The Chancellor stressed the need for Germany and its European partners to pursue “areas of mutual interest” with China, but without ignoring controversies.
  • This was followed by Xi hosting a number of conciliatory meetings with Western leaders on the side lines of the G20 summit in Bali (with the exception of Xi’s confrontation with Justin Trudeau). One particularly noteworthy meeting was between Xi and Australian Prime Minister Anthony Albanese, the first exchange between leaders of the two countries since 2016.

COVID

  • Following a tragic apartment block fire (which was under COVID lockdown), in Urumqi (the capital of Xinjiang), protests against draconian COVID policy broke out across China. The size, messaging and geographic spread of the protests was significant, with protestors hitting out against Beijing and the local governments tasked with implementing the policy.
  • While the unrest was inevitably met with a swift police response, it acted as a catalyst for the acceleration of Beijing’s reopening agenda. Protests were followed by a surprising acknowledgement by Xi of the frustration being felt by many Chinese people, the cancellation of routine mass-testing in multiple cities, a reduction in mandatory quarantine periods for foreign arrivals (“7+3” days in a quarantine facility/at home to “5+3”), and state media pushing a new narrative that the Omicron death rate/severity is very low.
  • The fear is that opening up will inevitably led to a huge spike in COVID cases, which threatens to overwhelm China’s healthcare system, and risk the lives of the elderly population that is under-vaccinated.
  • To address this, Beijing has set hard vaccination KPIs for local governments: by end of January 2023, the vaccination ratio of people aged over 80 should reach 90%, and 90% of the people aged over 80 who meet certain health criteria must be fully vaccinated and have received booster shots. Additionally, 95% of the people aged between 60-79 who meet health criteria must be fully vaccinated and have received booster shoots. Current numbers are a long way off these targets, so we expect to see the rollout of a massive vaccination campaign.

Michael Zhang’s China trip

  • Analyst Michael Zhang travelled to China to see family during the month of November and relayed his impressions of consumer sentiment and attitude to COVID:

“Depending on where you’re at, activity levels might vary a lot. Recently in Chengdu, most restaurants were open, food deliveries normal, but restaurants and shopping malls were a lot less busy. The situation literally changes by the hour, you live your life by constantly checking the local community Wechat group for any announcements and might be ready to sleep at your friend’s place if yours is suddenly locked down for a few days. At one point, 30% of Chengdu’s residential complexes was locked down (despite no city-wide restrictions), but many of them suddenly reopened after the change of tone at central government level. Local governments are also nervously watching the message from the top.

It may take longer for Chinese people to shift their mindset, even if governments suddenly announce “we’ve defeated the virus”, a lot of people will still be cautious and unwilling to come out and spend, plus COVID cases and deaths will be rising. With this in mind, the recovery in consumption may be more gradual than many expect.”

Korea and the Inflation Reduction Act (IRA)

Portfolio manager Mazika Li travelled to South Korea on a research trip, and found that the IRA is at front of mind for many Korean companies looking to pursue major investment opportunities.

Asymmetric opportunities

“Free money” – the U.S. government is doling out subsidies in the form of tax incentives and production tax credits to attract investment in its renewable energy and battery supply chain (to the exclusion of Chinese sourcing). The initiative budgets for US$30 billion per year for the next 10 years.

Three key components:

  1. Advanced manufacturing production credits – applies to solar, batteries, offshore and onshore wind technology.
  2. EV tax credits for car buyers for up to $7,500 per car. To claim the full credit:
    a) at least 50% of the battery components must be manufactured/assembled in North America (and will go up to 90% by 2029), and
    b) if at least 40% of the battery materials were extracted or processed from countries which have a free trade agreement with the U.S., or recycled in North America (stepping up to 80% by 2027).
  3. Investment tax credits for renewable, energy storage and critical minerals projects.

Who wins?

  • While building a U.S. plant is an expensive exercise, the strength of these incentives is such that Korean companies will be able to generate a healthy return on investment in a relatively short period of time.
  • Non-China suppliers of critical raw materials in the EV/renewable/battery supply chains should see increased demand.
  • Manufacturing equipment makers benefit from the capex spree.
  • The U.S. strengthens economic ties with allies in the West and East, and gains manufacturing know-how in key areas.