In brief

• In order to support the economy, China has been taking steps to relax COVID control policies. This should compliment more economic stimulus in 2023.
• However, the initial reopening may cause a spike in the infection curve, exacerbating pressures in the short term. We expect to see weak growth in early 2023, followed by gradual pickup later in the year.
• Market flow data reflects buoyant investor sentiment upon China’s reopening, and we stay constructive on Chinese equities. We remain neutral on CNY given the prospects of a U.S. dollar rebound in the near term.

Chinese domestic policies turned more growth-friendly

Against the backdrop of mounting growth pressure, aggressive changes have been made to China’s COVID control policy to relax mobility restrictions and support economic activities. We expect this to compliment more economic stimulus in 2023.

Since the announcement of a new 10-point guideline on December 7 by the National Health Commission, local governments have made big steps toward reopening. Most of the obstacles to cross-region travels have been removed, and negative PCR testing results are no longer required for most public venues and public transportation. Most importantly, asymptomatic and mild infection cases are now allowed to quarantine at home.

At the Politburo meeting on December 6, more proactive measures were proposed for economic policies in 2023. In order to maintain stability in economic growth, employment and inflation, a combination of proactive fiscal policy and prudent monetary policy was advocated. As for the real estate sector, emphasis on risk control and the supportive measures announced since November reflect the leadership’s goal to achieve a soft-landing in this sector. This meeting set the tone for the upcoming Central Economic Work Conference in late December and the National People’s Congress annual session next spring.

The road to recovery will likely remain bumpy in near future

The recent relaxation moves reflect greater tolerance from the Chinese government for rising infections. Meanwhile, the government continues to push for vaccination among older population while improving the efficiency of hospital system. Given the Omicron variant is highly transmissible, we could see a rise in daily infection numbers in the near term. Borrowing experience from other countries in their outbreak, this could bring temporary disruptions in the economic activities.

Meanwhile, consumer and business confidence may remain subdued till further stimulus measures take effect.  In addition, Chinese export value declined 8.7% year-over-year as a result of supply chain disruptions and weakness in foreign demand.

For the above reasons, growth momentum would take time to improve, with domestic demand recovery potentially offsetting the impact of weakening foreign demand. On such basis, an official growth target around 5% may be set for 2023, and we expect to see gradual pickup in growth rate throughout the year.

Investor sentiment remains buoyant upon reopening

In November, we see that A-shares led the major investor inflows with US$8bn (year-to-date: +US$10bn) via Northbound (Hong Kong to China), while Southbound flows (China to Hong Kong) were also strong at US$6bn (year-to-date: +US$48bn).  Autos, healthcare and consumer/ reopening sectors have seen the largest increase in allocations year-to-date within Chinese equities among emerging markets and Asian funds, while internet and media as well as energy have seen the largest reduction.

Exhibit 1: Stock Connect monthly net flows

Source: CEIC, Hong Kong Exchanges and Clearing Limited, J.P. Morgan Asset Management. Data reflect most recently available as of 12/12/22.

We stay constructive on China, on undemanding valuations, room for growth acceleration compared to developed economies with recession concerns, light positioning and improving credit impulse. We also favor sectors that gain from structural policy tailwinds.

Green Economy sectors, such as, electric vehicles and advanced manufacturing sectors are likely to play a more important role in generating growth over time, while relaxing zero-COVID policy should be able to boost consumption in the near term.

Picking the winners regardless of A or H

Instead of focusing on the debate of whether investors should choose between onshore A-share market or the Hong Kong H-share market, we favor sectors and companies in both markets that could benefit from improvement in growth momentum in 2023.

For the offshore indices, a lot of negativity is already in the price for this year and next. On top of compelling valuations, we think this presents itself a relatively attractive entry point for longer term investors.

For the onshore indices, as old China industries like industrials, materials, tech hardware still make up a big portion of these indices, over the shorter term, the focus on infrastructure investment and policy-driven investment themes like dual circulation, technological upgrading and import substitution could mean A shares remain resilient. A shares market also continue to remain less correlated with global indices.

Neutral on CNY

Having regained some ground in recent weeks, we believe that the outlook on the Chinese yuan (CNY) would be primarily driven by how the U.S. dollar (USD) behave, given that the CNY is managed against a basket of currency. In the near term, a hawkish Federal Reserve and prospects of weaker growth in the U.S. could prompt more risk aversion and benefit the USD, thereby applying fresh pressure on the CNY. This could however be partially countered by USD selling flows from Chinese corporates, which tend to pick up towards the year-end and ahead of the Chinese New Year, which may add a tailwind to the rebound in CNY over the short term.

In the medium term, reopening could narrow China’s trade surplus given stronger demand for goods and services by Chinese consumers. But the prospects of a weaker broad USD should keep the CNY relatively well- supported.

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