China under pressure

April 16, 2022

David Bailin

Chief Investment Officer and Head of Citi Global Wealth Investments

Steven Wieting

Chief Investment Strategist and Chief Economist

SUMMARY

The three-week Shanghai lockdown may have slowed the spread of omicron, but China’s Zero Covid policy is clearly failing. We expect further market support from Beijing in the shape of fiscal measures and monetary easing.

Several smaller cities are also under partial or full lockdowns. But despite these actions, nationwide cases continue to rise. Meanwhile, social discontent is rising, and economic costs are mounting. The only good news is that severe illness and deaths are extremely low.
The Purchasing Managers Index (PMI) data from auto and auto parts, computer and electronic equipment and oil refining are as bad as those reached during the Wuhan lockdown.
The speed at which Covid has surged and retreated across many geographies suggests that its impacts are temporary. However, the near-term outlook for Covid in Greater China will worsen the lingering supply/demand imbalances of 2021. And this will intersect with the commodity supply disruptions related to the war in the Ukraine.
It is now possible that China could experience a Q2 2022 GDP contraction. Fears of a recession in the second quarter would make China’s 5.5% growth target for 2022 unachievable.
Premier Li announced new fiscal measures to support the national economy. China’s central bank has just announced the first of several rate cuts and the March credit data points to a large credit easing.
Historically, the performance of Chinese equities has a strong positive correlation with the country’s monetary policies rather than its immediate economic performance. There is often a lag of a few months between the launch of significant stimulus and a rally in equities. According to our analysis, the valuation of Chinese equity markets is just 53% of the S&P 500, an historic low.
Given the expected additional fiscal policy stimulus and expected further monetary policy easing, Chinese asset prices will likely see support. We maintain our view that long-term investors should remain in China’s equity market.