China Watcher: Don’t Expect a Policy U-turn from Beijing

Investors have applauded a recent string of dovish domestic and foreign policy announcements from China in recent weeks, with the KraneShares CSI China Internet ETF (KWEB) up 35% and iShares MSCI China ETF (MCHI) up 24% through November. But Scott Moskowitz, senior geopolitical risk analyst for Morning Consult, warns that a full reversal in policy for the world’s second-largest economy is not yet on the cards.

VettaFi contributor Dan Mika sat down with Moskowitz to break down what investors can glean from the geopolitical situation surrounding China. This interview has been edited for clarity and conciseness.

Dan Mika, VettaFi: The last report from Morning Consult showed heightened tensions between China and the United States from its residents. But that happened before we saw quite a few things happening that I think gave investors reason to believe that China is starting to get more relaxed on a number of fronts.

Let’s start at the national level. Last week, the government said it would reduce quarantine time for travelers entering the country. But we are also seeing anger building in the streets over the extended COVID-related lockdowns. Peking University has just closed a file. What is your opinion on the current situation around the zero-COVID policy? To what extent should investors take this as a broader barometer of what the Chinese government thinks?

Scott Moskowitz, morning consultation: (China-related headlines) kind of fell and were pretty negative after the Communist Party Congress because a lot of what came out of that was that very little was likely to change in the near term. I think it was not surprising. It would have been a strange moment for Xi Jinping to reconsider his policy; he needed to project his forces. He couldn’t question this policy that he’s really staked his name on for the past couple of years. There have been some changes to quarantine timelines, particularly for inbound travellers. But I think the reality on the street is a bit different, and I think these things show up in different ways. I think the travel restrictions might appeal to global elites, especially Chinese elites who are fighting to get it out of the country. For multinational executives, it may not seem as impossible to get in and out of China. Whether that really convinces them to come back, the two-day shorter quarantine, is hard to say. But it doesn’t look like much has changed on the street. You see a lot of anger about individual lockdowns, and that stuff doesn’t seem to be stopping. It signals a specific intention, which can always have a positive bearing. But I’m not sure people are still seeing a real change in their day-to-day lives. I think there has been so much uncertainty about all the lockdowns. Every time it seems to get better, all of a sudden it gets worse. I think people are reluctant to really believe that everything turns around the corner. Of course, we saw a significant response in the market.

Vetta Fi: Sunday, Bloomberg reported that China has issued sweeping guidelines to support the real estate sector and support builders caught in this crisis. How much do you think that plays into recent market moves, given how much contagion fear Evergrande had last fall?

Moscow: I think it’s absolutely huge. The real estate sector in each country is very important. But especially in China, it has a really disproportionate importance. People invest a lot of their capital in real estate; it’s the only market they trust. Stock markets and capital markets are still not as stable and developed in places like China. Real estate has been the one consistent investment that has led to truly inordinate overinvestment in real estate, not just by businesses but by ordinary people. When the real estate market takes a hit, there’s just massive contagion in terms of consumer confidence. Any time something is done to resolve the real estate crisis will always be positive. But, as with everything, we’ll have to see if it’s too little too late and to what extent they can really turn it around because there’s so much to do.

Vetta Fi: On Sunday we had the reading of a three hour conversation between Biden and Jinping at the G20 summit. They agreed to restore communication on various issues, from climate change to food security. What does this bode for the future of Chinese politics, acting in a way that makes investors feel like it’s a less risky place to invest assets?

Moscow: I think that’s what has shaken the markets the most. In my last report, we saw that tensions were skyrocketing in the second half of the year, particularly since August, since (House Speaker Nancy Pelosi) visited Taiwan. This has certain political considerations that occurred in the run-up to the Communist Party Congress, where Xi was seeking that third term. It was a time when he couldn’t afford not to project his strength. I think in many ways the Chinese people were looking for that. They want their government to somehow protect their interests and the strength of their project.

But the rise in tension and its militarization, as much as people want, has really scared people. What we’re seeing in the data on our end is that people are going to start thinking, “Wow, this is a new normal.” When we ask people if they are worried that tensions will continue to escalate in terms of economic tensions, but especially military tensions, we have seen that this has really exploded in the last two months. Things really seemed to start to deteriorate, and then to get worse after the Communist Party Congress. Xi really put forward this tough attitude that nothing will change. I think what has spooked the markets now is that even the party’s latest moderating influence has been brushed aside when it named a slate of loyalists. This seemed to give them carte blanche to pursue an even more aggressive and assertive foreign policy. I really felt like nothing was going to change and things were going to get worse. But one thing we’ve found is that people on both sides – I’m not sure they know how to compromise – but they want to compromise. They want tensions to return. I think Xi recognized that now that he’s sort of safe and comfortable…and locked in for the next five years, I think there was a sense of need to put a floor under relations with people who were really scared. I think it helps to backtrack. There had been a hiatus in the high-level dialogue on several issues, and that conversation, at least, advanced the idea that this is not what China wants. They don’t want to cut off all communication with us; they want to show their strength. But they want to keep the dialogue going, and they want to work on things to come.

Biden was very explicit in the reading when he said he didn’t think China was planning to invade Taiwan in the near future. This is something that has particularly concerned China-related markets over the past few months. Since Pelosi’s visit, all of these companies had begun, for the first time, to think seriously about a time when they might have to leave the Chinese market (if there was) an invasion and when they might be constrained by geopolitics. They were already looking a bit further afield due to COVID-related supply chain issues. Now ask yourself if we really need to diversify outside of China. There were a lot of questions about the timing, the urgency of this diversification, and the degree of planning they needed to do. There was a sense that maybe nothing tangible had changed with the conversation with Biden, but it really seemed to push the timeline. We’re not heading into crisis yet, so it’s time to get it all figured out. Like I said, we’re trying to put a floor on relationships, which has really calmed a lot of raw nerves.

Vetta Fi: With all of this in mind, what do you think are the chances of China reversing this easing policy, both domestically and with the United States? I would say that since last September, China-focused ETFs have lived and died because of Beijing’s policy moves. How much should we read into the future right now based on these most recent events?

Moscow: I don’t think the talks really suggested any tangible changes, and the things that hurt a lot of these ETFs, especially tech stocks, were more about domestic politics. I don’t think Xi said anything, either at the Party Congress or when he met with Biden, that would really suggest a major shift on the domestic side in terms of his hardline against some of these larger sectors. he tries to control. But one thing about the talks I think more is that when the relationship is bad, you see more of an increase in aggressive moves back and forth related to trade, especially technology. We had the recent (US) semiconductor legislation and stuff that was really tough on the tech market, obviously. I think we are things that are settled bilaterally. There is some hope and how it would affect some markets, but I don’t see it as a turnaround. I see it more as soothing the nerves and trying to say, we’re going to try and bring the temperature down here.

They talked a lot about the need for compromise in the need for dialogue. But they didn’t say we were going to compromise that way we’re going to change our policy on that it’s going to be totally different I really haven’t seen anything to indicate that I think that’s really fair more about signaling, conscious effort to lower the temperature and it can be really beneficial. But in terms of real, tangible policy changes, I’m not sure we’ve seen that yet, or any real indications. Perhaps (zero-COVID policies) will be slowly, very slowly rolled back, and that could have beneficial logistical effects in terms of manufacturing and production and hopefully eventually consumer confidence. But in terms of all these policies towards their sectors and ring-fencing investment in certain sectors, I haven’t seen, I haven’t seen any kind of flip-flop there.

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