Will COVID cut short China's economic rebound?

After a few gruelling quarters for the country’s property sector, the authorities in China changed tack in early December and went into easing mode. This prompted us to go long Chinese and emerging equities relative to their developed-market counterparts, and we added to this position as easing signals strengthened at the start of the year.

The economy has shown signs of a turnaround since then and the trade has done well so far this year. However, there is an important cross-current that could derail the Chinese rebound: Omicron.

Zero-COVID versus living-with-COVID

With the virus more contagious than ever before, and its mortality reduced – possibly to a huge extent – compared with previous variants, the government might shift towards a ‘living with COVID’ strategy, as has happened in the UK and Denmark. In this case, we would not expect Omicron to pose a serious threat to the economic recovery.

This is not the path China’s leaders are likely to take, though. The most optimistic studies of the Omicron variant find that it is about 90% less deadly than previous strains (controlling for vaccinations and prior infections). Given previous mortality rates stood at roughly 0.5%, that leaves Omicron’s mortality rate at 0.05%. Even if this highly optimistic outcome came about, Omicron becoming completely dominant could still produce around 700,000 deaths among China’s 1.4 billion people were COVID allowed to spread freely. We think the Chinese authorities will find this number unacceptable and will stick to the zero-COVID strategy.

Health versus economy

So, what is the economic cost associated with zero-COVID, given that Omicron is so much more contagious and harder to detect due to milder symptoms? This is a tough call. If lockdowns were longer and more widespread, that would prompt a reassessment of our more positive China view.

Our base case is nevertheless that the authorities manage to suppress Omicron via localised lockdowns lasting no longer than two to three weeks, much in the same way they controlled the Delta variant (but with stricter border controls). This assessment is based on the experience they have gained over the past two years and acceptance of the broader strategy by the Chinese population. Compliance with the rigorous nationwide testing programmes and aggressive lockdowns across China remains strong, despite the two-year struggle to contain the virus.

So far, the data are consistent with our base case. A tracker that aggregates traffic in China’s 100 largest cities using population weights (illustrated below) suggests activity so far this year remains above levels in early 2021. This is despite recent Omicron outbreaks.

Of course, it is early days – and two events are about to stress-test the zero-COVID strategy.

Chinese New Year and the Beijing Olympics

First, the Chinese New Year, a time when rural city migrants return to their home villages, is the largest human migratory event each year and could spread Omicron nationwide. Second, the Winter Olympics from 4-20 February and held in Beijing also carries viral risks – with athletes flying in from abroad. Substantial enforced mixing could also prove a catalyst for new waves of infections and lockdowns, challenging our view of a China rebound.

We worry more about the Chinese New Year than the Olympics. The Olympics itself will be highly controlled with strict curbs on behaviour, complete with an isolation ‘bubble’ for all the staff, attendees and athletes involved. Chinese New Year is both a more widespread event and raises the risk of urban-rural transmission. If it passes without a major flare-up in cases, this will give us further confidence in our recovery scenario.

Barring a deterioration in daily activity indicators, we plan to stay in the long China/emerging markets trade and possibly top up if the Chinese New Year passes without major outbreaks.