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Spotlight on China’s next phase of economic recovery

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The turbulent 2022 has come to an end, and one of the most watched events in the global market has just kicked off. China, the world’s second-largest economy, is taking decisive steps to revive its economy after a three-year battle against the pandemic.

The situation turned in December last year. So far, China’s adjustments to epidemic prevention policies and support measures for the economy have been quite rapid and extensive.

At the central economic work conference in mid-December, policymakers said they would support consumption and private enterprises and stabilize the property market. While releasing the theory of stable growth, the government also announced the relaxation of isolation control measures that month.

First, the government canceled the centralized isolation requirement for people infected with the new crown virus. The National Health and Medical Commission announced that nucleic acid testing for inbound personnel will be canceled from January 8, 2023. This is an important development with major implications for the Chinese economy, international tourism and foreign companies operating in China.

Given that the Health and Medical Commission has downgraded the management level of the new coronavirus infection to “Class B and B”, it is unlikely that the lockdown will be implemented again in the future. The government’s current anti-epidemic stance has shifted to co-existing with the virus.

Stepping into 2023, we believe that China’s next stage of recovery is promising. However, investors should maintain a clear judgment on the future.

The road to recovery is bumpy

Relative to developed markets, where growth has slowed sharply, we believe consumption momentum in China is poised to recover in 2023. As the economy accelerates to return to normal, the annual GDP growth in 2023 is expected to pick up to around 5%.

However, even though the pace of China’s reopening under the new epidemic prevention guidelines has accelerated significantly, the challenges facing the medical system have also increased significantly.

Given the rapid rise in infections after reopening, growth is likely to remain subdued in the short term as business operations suffer as employees recuperate at home. According to reports, Chinese officials estimated that about 250 million people, or 18% of the population, were infected with the new coronavirus in the first 20 days of December. During the upcoming Chinese New Year holiday, the large movement of people may cause another surge in cases across the country.

In fact, it is not easy for many countries around the world to withdraw from epidemic prevention measures, whether it is due to doubts about vaccination or shortage of medical resources. In this regard, China is no exception. We believe that the peaking of infection-related data and improving travel conditions are key factors supporting a sustained rebound in economic fundamentals.

In terms of investment deployment, we believe that option strategies can help grasp the further upside of Chinese stocks, and can also ease the market volatility before the full and orderly liberalization. With policy changes, “beneficiaries under the optimization of epidemic prevention policies” include sectors such as pharmaceuticals and medical equipment, consumer goods, transportation, capital goods and materials. Internet platforms are also in a good position as the risk of Chinese stocks being delisted from the U.S. eases. These sectors are expected to see revenue growth and, even after the recent broad-based rebound in Chinese stocks, valuations could rise.

In terms of real estate, the Chinese government may introduce more demand-side measures to stabilize housing sales, such as lowering taxes and even issuing subsidies, while housing sales continued to decline in December, with a year-on-year decline of 40-50%. With Foshan and Dongguan announcing the complete removal of purchase restrictions, more major cities may introduce similar measures. In the short term, high-quality developers are expected to refinance through loans and bond issuance, and in the long run, they may reduce leverage through equity financing and real estate investment trust (REIT) issuance.

In view of this, investment grade and BB grade credit bonds are expected to rise further. After the government launched the “Financial 16” relief measures in mid-November, the total return index of investment grade bonds of Chinese real estate companies has risen by 7%, and the BB grade index has surged by 49%. The yields of the two are expected to increase in the next 6 to 12 months Monthly further narrowed to 6.5% and 15% respectively.

In 2023, China’s current account surplus should shrink as outbound tourism and imported consumption increase. This may slow down the yuan’s steady appreciation, but it won’t change its course, given favorable conditions for investment inflows. If the pace of reopening is faster than expected, USD/CNY could reach our September 2023 target price of 6.7 in the first half of 2023.

It’s important to be flexible

Broadly speaking, the reopening of China is in line with our general view that global market movements in 2023 will likely be driven by policy shifts in China and around the world.

In the US, the latest Federal Open Market Committee (FOMC) meeting indicated further tightening of monetary policy is still needed. We expect S&P 500 earnings to contract by 4% in 2023, compared to the current bottom-up consensus forecast of 5% growth, which we believe may be too optimistic.

Therefore, the market volatility may not be over yet. We expect an inflection point in US inflation, monetary policy and economic growth this year, but the fundamental conditions for a sustained recovery may not yet exist.

Overall, we continue to take a defensive stance in equities and are also bullish on high-quality bonds. Over time, growth and riskier credit will become more attractive once inflation continues to fall back toward 2% and conditions are met for the Fed to consider easing policy. Before that, we recommend that investors respond flexibly and remain cautious.

2022 is not easy for investors. But in the long run, lower stock valuations and higher bond yields mean that a diversified portfolio can pay off handsomely over the long term. This is why we remain optimistic about the future.

(The author is chief investment officer of UBS Wealth Management Asia Pacific. This article only represents the author’s opinion. Responsible editor email: Tao.feng@ftchinese.com)

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