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The Big Conversation

Episode 151: Is it too soon to cheer?

Chinese equities have been rallying for a month in expectation that COVID restrictions would be lifted. Despite this, commodities and other global assets that should have been affected have yet to provide anything more than false starts. This week, however, we got the definitive news that restrictions were being lifted meaningfully and we assess whether this is now the time that commodities finally make their move higher.

  • Jamie [00:00:00] The S&P 500 has rallied almost 15% from its October lows to recent highs last week. And yes, there has been good news to cheer about. U.S. inflation, which has been dominating and will likely continue to dominate conversations for the coming months appears as though it has peaked and the Federal Reserve has got it under control. Three cheers for monetary policy. But in one particular area, there are even bigger reasons for holiday cheer. It's an area of economic focus that touches the hearts of Americans more than most - prices at the pump. According to the American Automobile Association, gas prices are now below the levels they were on the eve of Russia's invasion of Ukraine. But not so fast, this week we also got major COVID restrictions being lifted in China, and we ask ourselves whether it's simply too soon to cheer. That's this week's Big Conversation.

    Jamie [00:00:56] We've spoken in previous episodes about the significance of China's COVID zero policy on commodities and the rest of the world as it slows down. And this week, we got hard evidence that the restrictions are being lifted in the most meaningful way since the pandemic began. And we await to see what effect this has as this can and will affect U.S. markets. On Tuesday this week, people in China's capital, Beijing, were allowed to enter parks, supermarkets, offices and airports, all without showing proof of a negative COVID-19 test. And on Wednesday, even more restrictions were lifted nationwide, allowing people to self-quarantine instead of going to state facilities, something that people were particularly upset about. In fact, a headline in the local paper read 'Beijing Readies Itself for Life Again'. Now, it is difficult to put any material numbers on what this will do to things like commodity prices, but Chinese equities performance are a good place to start as they are a leading indicator. The Hang Seng index is up about 30% off the lows this quarter with the whole index jumping 4% on Monday. So you can see, although the restrictions are only being lifted now in any meaningful way, local Chinese equities have been rallying hard for a month in anticipation of exactly this happening. Well, those relaxation measures must be priced in, then I hear you ask? Well, perhaps not. Oil, copper, gas and other commodities are still soft compared to recent levels, meaning that this news has only really impacted markets locally. We've yet to see any meaningful impact from the changes in China in the world economy. So what could happen? Well, on this latest news, Brent crude did move up 1.4% to $86.75. But that is a far cry from where we have been earlier in the year. The real question we need to be asking ourselves is if China continues to relax the restrictions, do commodities go back to near highs? So far, the only reaction in commodities has been headline driven, meaning this news has only brought about brief but powerful rallies. For the most part, those rallies have quickly receded as there are still lingering concerns about the global economy. Take, for instance, the most recent ISM Manufacturing PMI, which finally fell below the contraction threshold of 50. Underneath that headline figure, the subcomponents gave additional cause for concern. The report on New Orders fell back near September lows and has now been in contraction for five out of the past six months. The employment component also fell into contraction for the fifth time since the beginning of the second quarter. A robust labour market, they say the picture isn't so clear. According to at least this leading survey. And then we had Prices Paid, which collapsed to its lowest level since May of 2020. Now on the flip side, US ISM Services jumped to 56.5 from 53.5, and that adds some weight to a more hawkish Fed. So why is this news of China reopening so important for investors to monitor as we head into 2023? Well, many arguments as to why China's stimulative fiscal policies have fallen on deaf ears over the past several months, is that stimulus means very little if people are locked inside their homes. The rationale being you can print all the money you want, but if the Chinese people can't move about the country and spend their money, it leaves a lot to be desired in terms of overall economic impact. And that's why these recent developments are so important. If the Chinese leadership continue with their plans to reopen, all the fiscal stimulus they've released might finally make its way through the global economy. In fact, if we judge solely based on the broad M2 Money Supply, China has been throwing more fuel on the fire than they did during the initial COVID surge back in 2020. There are also rumours that the central bank will expand its bond-buying programme to buoy its property developers, the very sector that was at the heart of its painful deleveraging just last year.

    The important thing to remember here is that markets finally appear to be taking notice of all these developments. For the vast majority of the year headlines of increased stimulus from Chinese policymakers, has had very little to no impact on major asset prices. Rallies were quickly sold because, as we just outlined before, the COVID restrictions overruled just about everything. But if the 80% rally off October lows for the Hang Seng Mainland Properties Index is any indication, this just might be a true turning point. There's also another angle here. Politically, it appears as though China is conceding to the protesters in an unlikely move that some might see as a weakening of the dictatorship. Yes, Jinping has recently won a third term, so is perhaps less concerned about 're-election', but China does not typically fare well when instability arises. My point here is to keep an eye on the politics as it's not quite as simple as equities and commodities rally if rules are relaxed.