Chinese stocks rebounding as 2022 ends

Chinese equities — which have languished this year due to the economic fallout from Beijing's whack-a-mole approach to quashing COVID-19 outbreaks — are rebounding strongly as 2022 draws to a close, buoyed by the promise of kinder, gentler policies to come.

Since November, when the government started to walk back highly restrictive policies that locked down cities as big as Shanghai and left hundreds of millions grappling with severe mobility restrictions, Chinese companies listed in Hong Kong have rebounded more than 35%.

Even so, the benchmark index for those H-share companies remains down 17% year to date.

Indexes for Chinese companies with American depository receipts, meanwhile, have jumped more than 50% over the past six weeks, but remain down roughly 14% for the year. Benchmark indexes for Chinese A shares listed in Shanghai and Shenzhen, markets dominated by local retail investors, have seen more modest gains of 12.3% and 18.7%, respectively, from April lows. Shanghai's index remains down roughly 12% from the start of 2022 while Shenzhen is 18% lower.

Market veterans say continued progress in freeing up China's economy from pandemic-related restrictions should unleash pent-up consumer demand, powering further gains for Chinese stocks and potentially providing a boost for the global economy as well.

Consumption in China has been "massively restrained" this year but that money hasn't disappeared, said David Townsend, managing director of Europe, Middle East and Africa business with Value Partners Group Ltd., a Hong Kong-listed China equity boutique with $5.2 billion in assets under management as of Oct. 31.

It's there waiting to be spent, and if the government is moving now to relax rules around COVID-19 for both local companies and the man on the street, as opposed to paying any price to suppress it, there's "huge potential in this system to be unleashed," Mr. Townsend said.

"Household bank deposits have increased by 42%" since Beijing's COVID-19 policies effectively left Chinese consumers in enforced savings mode, with plenty of spending power should optimism about the economic outlook revive, agreed Andy Rothman, investment strategist with Matthews International Capital Management LLC — known as Matthews Asia — a San Francisco-based Asian equity boutique with $17.4 billion in assets under management as of June 30.

For the moment, stocks are surging more on the promise of fewer pandemic constraints than on concrete steps in that direction, and some market participants warn that investors may be getting ahead of themselves.

"Finally, we've seen some genuine, albeit marginal, loosening," and investors' willingness to move in anticipation of consumption recovering is justified, said Sat Duhra, a Singapore-based portfolio manager overseeing roughly $1 billion in Janus Henderson Investors' Asian dividend income strategies.

Mr. Duhra counts himself as one of those investors, having added a number of beaten-down Chinese domestic consumption-focused stocks to his portfolio this year. The weight of China in his regional strategies has risen to between 13% and 14% from a record low of 10% at the start of the year, he said.

On Dec. 7, China's National Health Commission issued a notice on "further optimizing and implementing" pandemic prevention and control measures, following up on an initial package of 20 optimization measures announced on Nov. 11. The latest notice called for more surgical delineation of "high risk" pandemic zones subject to the greatest mobility restrictions to floors of buildings, for example, rather than entire residential areas; reducing the scope and frequency of testing requirements; and allowing for infected people to isolate at home rather than in centralized isolation facilities, among other things.

Investors didn't seem overly impressed, with the benchmark China H-shares index closing down more than 3% for the day. But amid a steady stream of news about easing moves by municipal governments in major cities such as Shanghai and Beijing, Chinese stocks ended the week with solid gains.

Mr. Duhra said the fact that the market in recent weeks has been so enthusiastic in embracing reports that, for example, people in Shanghai may no longer need COVID-19 tests to go on public transport or have to register all of their details at pharmacies in order to buy cough medicine "just reminds you how stringent this was" and that a considerable number of onerous rules remain in place.

More importantly, Mr. Duhra said, investors would do well to remember that China's market was facing a number of challenges before COVID-19, from surging household debt to a crumbling property market. In that sense, the loosening of pandemic constraints, while welcome, "is not the solution to China's problems," he said.

Still, even if the road back to normality proves a long one, market participants say the change in policy direction is giving global investors more reasons to consider Chinese stocks trading at valuations last seen around the time of the global financial crisis and backed by one of the few central banks this year in easing mode, at a time when U.S. and European stocks are facing earnings downgrades as central banks fight inflationary fires.

Progress toward reopening China's economy, together with parallel policy steps last month to support the country's property sector and recent signs of moderation in U.S.-China tensions, are all reasons to be more optimistic about Chinese equities as a new year dawns, said Shuyan Feng, a Hong Kong-based portfolio manager focused on Chinese equities with Eurizon Capital Asia Ltd.

Ms. Feng said investors, meanwhile, shouldn't anticipate a fast-paced retreat from COVID-19 restrictions.

"Given China's constraints in terms of the numbers of intensive care unit beds per capita, they'll still want to reopen at a gradual pace" — a "0.5 version" of current policies rather than an abrupt end to mobility and testing constraints, Ms. Feng said.

"It's not going to be a straight line by any stretch of the imagination, agreed Value Partners' Mr. Townsend. Still, "we're quite confident in the direction of travel," he said.

Case in point: the response of Chinese policymakers to a recent spike in cases of the highly transmissible Omicron COVID-19 variant in the southern Chinese city of Guangzhou suggests a newfound restraint that should help sentiment and consumer confidence revive, Mr. Townsend said.

They've effectively said "there is no lockdown. Go to work. Go to restaurants," Mr. Townsend noted. If people, as a result, can say, "well, actually things are going to loosen up, there is going to be this return to normality, the opportunity in China is immense," he said. And that, in turn, will be "really beneficial for the economy, which is going to be beneficial for stock markets, which is going to be beneficial for investors," he said.

Given the size and importance of China's economy, investors globally could share in those benefits as well.

Signs that China could be narrowing or even ending its zero tolerance COVID-19 policies could have "huge implications from a global perspective, both for them as a country but also for others that deal with them on a regular basis" on issues such as supply chain shortages, said Deborah A. Cunningham, executive vice president and chief investment officer, global liquidity markets with Pittsburgh-based Federated Hermes Inc.

The end of shortages out of China could lower the risks of a U.S. downturn, she said.

"The impact of Chinese demand picking up on global growth could be quite significant," offsetting at least some of the drag on global growth from slowdowns in the U.S. and Europe, agreed Janus Henderson's Mr. Duhra.

Still, he predicted, any revival of animal spirits in China is likely to take time.

An early December report by Goldman Sachs Group Inc., exploring different scenarios for China's move away from COVID-19 restrictions, said a controlled reopening was most likely, with some immediate steps to ease the burdens on Chinese citizens but overall progress moderated to avoid putting too much stress on the country's health-care system. Under that scenario, Goldman predicts China's GDP growth will rebound to 4.5% for 2023 from 3% this year, and improve further to 5.3% in 2024 — still below the 6% level the country achieved in 2019, the last full year before the onset of the pandemic.

One sticking point, the Goldman report said, is how quickly Beijing can get the over-80 segment of China's population — the weak link in its vaccination efforts with only 40% having received booster shots — protected. The government last month launched a campaign to quickly boost the ranks of vaccinated seniors.

But Bo Zhuang, Singapore-based senior sovereign analyst with Loomis, Sayles & Co. LP, in a 2023 outlook presentation on Dec. 6, said the outbreak in recent weeks of protests in cities across the mainland against pandemic restrictions has likely changed the calculus for a Chinese leadership that sees social unrest as a greater danger than pandemic-related health challenges.

Mr. Zhuang said China's leaders are likely to accept a "shock therapy" approach, with a rapid elimination of restrictions resulting in an explosion of new cases and hospitals being overwhelmed for a brief period.

Steps taken so far have already resulted in a sharp pickup of COVID-19 cases in China, analysts said.

The number of cases has already gone up from 2,000 a day to more than 30,000 and they're still tentatively reopening, noted Mr. Duhra, who continued to hold out hopes for a less disorderly outlook than Mr. Zhuang depicted.

"If we can get through the winter" without the increase in COVID-19 cases swamping China's health-care system and if they create the right kind of credit and liquidity conditions, then momentum can continue, he predicted. "There are a lot of 'ifs' there but there is certainly a scenario where you could see that happening and valuations and earnings actually support that because they've come down a lot, so I think it's reasonable," he said.