There seems little prospect of a speedy reversal of China’s zero-Covid policy or its growing tensions with the rest of the world, argues Investec’s John Wyn-Evans
Recent international headlines have focused on China. Protests against president Xi Jinping and the Communist party, that broke out in cities including Beijing, Shanghai and Wuhan, followed initial disquiet about Covid cases reaching a new record high in the country.
The catalyst was initially a fire in an apartment building in Urumqi, where the deaths of residents were blamed, at least in part, on Covid restrictions which both stopped people leaving the building and the fire services from tackling it. Negative sentiment in the country has been exacerbated by broadcast pictures from the World Cup showing massed crowds enjoying the football without masks or other restrictions.
Beginning of the end?
Nobody can be quite sure where this leads, although some commentators have suggested it could mark the beginning of the end for Xi and the party. But is that wishful thinking? Xi cemented his power at the recent National Party Congress and seems to be unopposed in his desire to continue to reverse the trend of previous decades when the country appeared to be becoming more “open”.
Anyone drawing parallels between this situation and the demise of the Soviet Union would do well to remember that the Soviet leader of the time, Mikhail Gorbachev, was instrumental in dismantling the iron curtain, or at least not standing in the way of change. It is hard to see Xi taking such a course, especially in a culture where changing one’s view often represents an irredeemable “loss of face”.
The growing mistrust between China and the rest of the world is resonating globally. In the UK, Whitehall departments are banning Chinese-made surveillance equipment on sensitive sites owing to perceived security risks. In China, Tesla vehicles are reportedly being banned from entering military areas. Military staff, plus employees of certain state-owned companies, are not permitted to drive a Tesla. In the US, several Chinese telecoms equipment companies have been banned by the FCC (the regulator) from selling their wares.
None of this bodes well in the short term for Chinese assets, nor for sectors and commodities associated with a fuller reopening of China’s economy. Many China-sensitive companies and commodities bounced strongly recently as the government announced first a 16-point plan to alleviate pressure in the real estate industry, followed by a 20-point plan to exit its zero-Covid policy.
Supply chain risks will also come back to the fore for Western companies sourcing either components or finished goods from China. Apple is the example with the highest profile. A Bloomberg report suggested a production shortfall of 6m iPhone 14 Pro and Pro Max handsets, the company’s most in-demand, premium offering. Apple recently reduced its 2022 production forecasts from 90m to 87m units, with further downside possible.
Even so, we also must be mindful that any share price overreaction to short-term (and one would hope) one-off profit shortfalls, can offer an attractive entry point to companies that are long-term compounders of value.
Way out
Having said all of that, it seems inconceivable that China will remain locked down in perpetuity. It is not as if they do not know what they need to do in terms of vaccinating the population. The biggest risks remain with older cohorts. One third of over-60s (amounting to around 90m people) have still not received the crucial third dose. But national pride over having to use a foreign-made mRNA vaccine seems to be getting in the way of pragmatism. Optimistically, a wider-reaching vaccination programme could begin to be rolled out within weeks, even though it would not be early enough to prevent restrictions during the winter. But at least then, investors could anticipate more normal activities resuming by the spring/summer of 2023.
We still believe that we will be offered more timely opportunities to increase equity risk in portfolios, particularly in the US. But with the UK seemingly already in recession, Europe odds-on to follow and the US expected to enter recession within the next 12 months, uncertainties in China add to our list of market influences expected to keep us on a bumpy path well into the New Year.
John Wyn-Evans, head of investment strategy, Investec Wealth & Investment
