In January, it’s not unexpected to be inundated with outlooks for the rest of the year. However, while views on what will happen with inflation and interest rates are rife, there is one problem which seems to be going under the radar and it involves the host of the upcoming Winter Olympics.
On February 4, Beijing plays host to the XXIV Olympic Winter Games. For just over two weeks, among a host of events, we get to enjoy the spectacles of Ice Hockey, Alpine Skiing, Figure Skating and Skeleton, but there is another contest that we suggest investors will want to keep an eye on.
Zero-Covid Strategy
As the eyes of the world once again fall on China, it is the country’s resolve to continue with its zero Covid strategy which is causing us concern. While the rest of the world is learning, slowly, and with some difficulty to live with Covid, in China, authorities are doubling down in an attempt to stamp out the virus whenever it appears, and at any cost. At IBOSS HQ we have called this the “whack-a-mole” approach.
The problem is that China has yet to experience large numbers of Omicron cases, so when the variant arrives – and it will – something will have to give. Reports that vaccines made by domestic firm Sinovac Biotech Ltd offer limited protection against Omicron will likely reinforce China’s resolve to stick with its Covid-zero approach. We think this is a significant economic risk and the results could be even more severe than when the Delta variant was dominant.
With Delta, the Chinese authorities were able to keep the virus under control, this was because it was not as transmissible in comparison to the hyper-transmissible Omicron. So, while the onset of Omicron may not result in many deaths, it could play havoc with the Chinese economy.
Supply Chain Issues
Given that China is such a huge part of the global supply chain, this is not just a worry for China and emerging markets, but it is potentially a serious problem globally too. You either let Omicron spread or the supply chain collapses, or at best comes under unprecedented pressure.
As investors, to help combat further supply chain problems, the areas to be overweight in are assets such as commodities and value plays, and underweight those areas which are expensive relative to history.
Outlook
So, what plans do we have for Chinese exposure across our ranges?
Whilst it would be easy to be negative on China for all the macro reasons, in 2021 we saw the biggest year difference between Chinese equity and North America equity performance. By just being invested in the US and staying clear of China an investor would have gendered close to 50% of returns. So, there are not just macro factors weighing on China, there is now a huge valuation difference to consider, which could prove to be an opportunity.
At the same time, given last year’s regulatory crackdown, some of China’s smaller company’s also look quite attractive. It is not quite as black and white as us saying China is going to face lots of problems in 2022 because, while it will, it has already had a year of phenomenal issues. It all depends on just how much these new problems will affect valuations.
To reflect our cautiousness, we have just added the JPM Global Macro Fund into the model portfolios for the first time in a long while. This fund is relative to equities and given the fundamental backdrop appears to be changing, it is a good hedge for the model portfolios.
There is a real risk of investors becoming blind-sided about conversations regarding inflation, but other events, such as what ‘s happening in China, could pose equally as many problems.
For now, China’s aggressive approach to Covid may allow them to host the Olympics as safely as can be expected. But how the virus will ultimately perform there throughout the Games, and after them, will be the contest we keep a close eye on over the coming weeks and months.
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IAM 22.1.22
