Strategy Dashboard:

Diagnosing Covid-Zero

Q2 2022 – May

As the world’s second largest economy and nucleus of global supply chains, China has a substantial influence on global growth. An informed view on the trajectory of the Chinese economy is thus imperative to all macroeconomic forecasting and investment-related decisions. At times, this is easier said than done. Understanding the Chinese political system can be challenging, as cultural norms, governmental priorities and institutional structure are quite different than what we’re accustomed to in the Western world. We have worked diligently (and continue to do so) to broaden our understanding. With significant financial market and economic volatility in China of late, an updated summary of our views is in order.

It is instructive to first review the background and events that helped inform our current outlook. A tug-of-war emerged in recent years between two of China’s strategic priorities: fostering economic prosperity and rectifying systemic financial risks and imbalances. Additionally, confrontations with the US escalated sharply during the Trump administration years, as tariffs and other trade hostilities necessitated an increased focus on self-sufficiency and innovation. In 2021, a campaign to rein in credit growth, real estate market speculation and regulate the nation’s internet sector caused economic and financial market tremors. Property developers faced a severe financing squeeze and foreign capital fled the bellwether Chinese internet stocks.

By late 2021, the writing was on the wall. Policy priority had to shift from regulation to stimulation to avoid the deteriorating economic fundamentals from snowballing into a widespread downturn. The tide began to turn slowly, starting with cuts made to banks’ reserve requirement ratio which boosted domestic liquidity. For the policy-driven Chinese stock market, things were starting to look up. Enter lockdowns. Whereas most of the world has shifted to a “living with the virus” strategy, China locked down Shanghai and numerous other major cities, citing a zero tolerance approach to COVID outbreaks.

In the near-term, the damage will be severe. Per the chart below, retail sales and industrial production have already plummeted after recovering sharply from the initial COVID lockdowns in 2020. Public health measures are admittedly much harder to predict than economic ones. However, similar to the regulation-induced slowdown, policymakers can only tolerate so much economic pain. We don’t profess to know the exact reopening timeline or the commitment of Chinese leadership to “COVID-zero” policies. But the economic alarm bells have officially been rung. Premier Li Keqiang hosted a rare nationwide address to local government officials urging economic relief, while Shanghai is ending the majority of lockdown restrictions as of June 1st (and simultaneously rolling out 50 measures to stabilize the municipal economy).

What conclusions can be drawn from this unfolding situation? For the global economy, the short-term implications will clearly be negative. The “sudden stop” in Chinese economic activity will have far-reaching knock-on effects felt around the world; compounding the impact of the commodity price shock brought on by Russia’s invasion of Ukraine. However, lockdowns will ultimately pass and serve to accelerate a pro-growth pivot from Chinese policymakers that was underway before the COVID outbreak began. This should provide a critical support to global GDP and help offset the hawkish bias of developed market central banks. As for Chinese stocks, the year-to-date dramatics have led to sizable outflows and contracting valuations. This is a favourable setup for future returns, especially considering the inherent sensitivity of the asset class to changes in policy settings.



Cash and equivalents’ ability to dampen portfolio volatility is attractive currently, as war-induced market jitters are likely to persist in the near-term. However, the recent commodity price shocks will delay the cooling of inflationary pressure, which will exacerbate purchasing power erosion for cash holdings.We have raised cash modestly to near-neutral levels in client portfolios.


Emerging market (EM) bonds remain one of the few viable sources of real yield in global fixed income markets. We previously expected that EM rate hikes were nearing an end, but surging commodity prices will likely extend the cycle. We maintain our overweight positioning in EM debt, but have decreased exposure this quarter.


Indiscriminate selling has created numerous opportunities in global equity markets, as stagflation risks have been over-estimated. Critically, the world’s two largest economies (the US and China) should prove resilient as US households are in solid financial shape and Chinese policy momentum had been building before the onset of lockdowns and the war in Ukraine. We have bought into the market weakness; further increasing equity exposure in client portfolios.


Hong Kong and Australia both provide exposure to the pivot to stimulative policy in China. However, a low vaccination rate in Hong Kong continues to necessitate punitive COVID lockdown measures, while Australia stands to benefit from Russian import substitution. We have decreased Hong Kong equity exposure in balanced and growth-oriented strategies and added to Australian equity exposure in income and balanced-oriented strategies this quarter.
Portrait of David Kletz, VP & Portfolio Manager of Forstrong Global.

David Kletz

Vice President, Portfolio Manager

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