Another Source of Potential Falling Uncertainty: China’s Lockdowns

If we were allowed just two words to sum up the financial world’s reaction to China’s Q1 GDP release, they would be “yah” and “but.” As in, yah, that 4.8% y/y growth beat expectations and is mostly in line with the government’s target, but that was before half the country went back into lockdown.^[i] A fair point, and the risk of a contraction in Q2—which some outlets now project—is also worth considering. In our view, China’s economic and COVID setbacks likely add to this year’s early uncertainty—yet they also create opportunities for uncertainty to fall later this year as early headwinds fade. High and falling uncertainty is often positive for stocks, and we think it should be a tailwind as 2022 rolls through its back half.

While it is true that China’s Q1 data don’t give much insight into the latest lockdowns’ impact, the accompanying March monthly data offer some clues. Unsurprisingly, they show the restrictions hitting consumer activity hardest. Retail sales fell -3.5% y/y and -1.9% m/m, with the latter (and month-over-month data in general) featuring rather prominently in the National Bureau of Statistics’ (NBS) release.^[ii] As always, we would take that with a grain of salt, as China’s seasonal adjustment methodologies are young and unproven, but it seems rather telling that officials seem increasingly ok with shedding light on negative data. It will also give us a chance to more clearly assess the damage as lockdowns spread from Shenzhen to Shanghai in late March, reaching dozens of other major cities in April.

Developments in industrial production will also be worth watching, as it held up fairly well thus far. Heavy industry grew 6.5% y/y in Q1 overall, with industrial production up 5.0% y/y in March.^[iii] It also eked out 0.4% m/m growth, but that coincides with the early parts of Shenzhen’s and Shanghai’s lockdowns, when factories were still managing to operate as bubbles and keep output flowing.^[iv] More recent reports indicate supply chain troubles have prevented factories from getting components, so industrial production could very well take a hit in April. Same goes for exports, which jumped 10.7% y/y in Q1, including a 12.9% y/y rise in March (China doesn’t publish month-over-month trade data yet).^[v] If factories can’t assemble final goods for shipment overseas, then exports will probably weaken. Imports, however, we wouldn’t read much into. Ordinarily, we would interpret their -1.7% y/y drop as a potential sign of weakening domestic demand, but the global supply chain weirdness that has companies opting to ship empty containers back to China rather than wait to load them up continues.^[vi] That is probably skewing the data to an extent.

Regardless, it seems obvious that locking down major cities and anywhere from one-third to half the population, depending on who is counting, will do some economic damage. China’s national lockdown in early 2020 caused a contraction, and this could, too. That is a negative. Yet there are also some factors that should help mitigate the market impact. For one, when China locked down in 2020, the rest of the world did, too—if only China had gone that route, the world could very well have avoided a global recession. That is key because China is now the only major nation pursuing a zero-COVID strategy. The US, UK, Europe, Japan and Australia have mostly moved on. All of these economies are heavier on services than physical goods, which should help limit the impact of disrupted manufacturing in China. There will be winners and losers, but for now, the net balance should still be positive.

Two, stocks now have a solid blueprint for lockdowns—they aren’t the mystery they were in early 2020. We know they hit output hard. But we also know there is usually a strong rebound once economies reopen, and activity gets delayed rather than erased. That points to a big catch-up boom in May, June or whenever Beijing lets cities reopen, especially if that comes with a big side of stimulus ahead of this autumn’s National Party Congress, where Xi Jinping is still seeking an unprecedented third term as party leader and Chinese president.

This matters because stocks look about 3 – 30 months out, pricing in expected events over that span. If improved Chinese growth relative to present fears is the likely scenario in that window, which we think it is, then it adds global economic tailwinds and helps reduce uncertainty. By then, we should have more concrete data showing how the Western world is coping with the dislocations from the war in Ukraine, not to mention falling political uncertainty as the French and Australian elections resolve, followed by US midterms’ likely gridlock boost later this year. The mere prospect of clarity on all of these fronts should help bring markets relief.

Even a Chinese economic contraction can help uncertainty fall. Getting the numbers will answer the how bad is this? question. It lets businesses and investors move on to the next thing. And if some market negativity accompanies or precedes it, then people can have their I was right! moment, too—more moving on.

So don’t dwell on what just happened or what could happen tomorrow. Look where markets do, at the next 3 – 30 months, and get ready for falling uncertainty.