China’s Damaging Lockdowns Are Informed by Hong Kong’s Deadly Experience
Stock market routs in China have usually been preceded by policy mistakes and the latest one is no exception. Government policy mistakes are not limited to China, of course. The world’s current bout of inflation, its worst in 40 years, has been largely a result of policy failures by governments around the world, most notably in the United States, where the combination of the Fed’s ultra-loose monetary policies and excessive fiscal stimulus goosed consumer demand while the supply side of the economy struggled to keep up following Covid-induced shutdowns. What makes China different, however, is the fact that its market is still dominated by retail investors who tend to have much less patience than institutional investors for market declines, and the country’s strict capital controls that make it, essentially, a semi-closed market despite years of reforms designed to open it up to foreign investors.
While the market’s most recent crash may be rightly blamed on the government’s damaging and draconian lockdowns of entire cities and regions since the Omicron variant of Covid-19 started spreading earlier this year, the seeds of China’s current problems can be traced to policy mistakes that started at the outset of the pandemic in early 2020. We now know that mRNA vaccines being developed by BioNTech, Pfizer’s German partner, and Moderna showed significant promise as effective means of neutralizing Covid-19 as early as February 2020. Governments around the world raced to test and approve these vaccines, rushing them to market in record time. By December 2020 mRNA vaccines were receiving wide approvals across the world and the pharmaceutical companies that made them raced furiously to expand their manufacturing also in record time.
As early as March 2020, BioNTech announced an agreement with Shanghai Fosun Pharmaceutical Group, one of China’s largest pharmaceutical companies, to jointly develop and test the German company’s mRNA vaccine for potential manufacturing and distribution in China. In December of 2020, as mRNA vaccine manufacturing was ramping up globally, the two companies announced an agreement to provide China with 100 million initial doses of the BioNTech vaccine “subject to regulatory approval.” Such approval never came. China chose to focus on developing its own mRNA vaccine, something that has yet to happen, while ramping up the manufacturing of Sinovac, its inactive virus vaccine used widely across the world. While it engaged in “vaccine diplomacy” to outdo Western governments in supplying shots to the developing world, it prioritized a policy of zero-Covid at home over widespread inoculation of its own citizens. Early successes with lockdowns in Wuhan and other areas of the country led Chinese authorities to believe they could keep the virus at bay, which bred a dangerous sense of complacency among its population, until Omicron arrived.
Omicron Ravages Hong Kong
Authorities in Hong Kong sounded the alarm on a possible Omicron outbreak on January 5, 2022. At the time other parts of the world had been dealing with the highly transmissible variant, against which booster mRNA shots were proving to be very effective at reducing hospitalizations and neutralizing the worst effects of the virus. Thanks to the wide availability of vaccines governments around the world were able to pursue more balanced and sensible Covid policies that did not require massive shutdowns, draconian restrictions, and the ensuing economic damage they wrought. Most importantly, many governments around the world had focused on vaccinating their elderly populations and those most vulnerable to the virus ahead of any future outbreaks. In countries like the U.S., where large parts of the population had contracted Covid in the last two years, natural immunity helped many avoid significant complications from the new variant.
Before Omicron surged in Hong Kong, scientists estimated that only 1% of the city’s population had ever contracted the virus, and thus very few people had developed natural immunity against it. Worse, however, was the fact that less than one quarter of people aged 80 or older had been given two doses of any vaccine, compared to more than 90% in Singapore and New Zealand, for example. By the middle of March, as Omicron raged through the city, Hong Kong had vaccinated only 39% of its residents over 80 despite having already inoculated almost two thirds of people between the ages of 12 and 19. To make matters worse, most people in Hong Kong were given the Chinese Sinovac vaccine, which is less effective than the mRNA vaccines. A study conducted by Yale and the Dominican Republic and published in the journal Nature Medicine in January, “showed that omicron infection produced no neutralizing antibodies among those who received the standard two-shot regimen of the Sinovac vaccine. Antibody levels against omicron rose among those who had also received a booster shot of the mRNA vaccine made by Pfizer-BioNTech.” As Omicron spread throughout the city, the virus began killing people at a rate that exceeded that of almost any country in the world, in stark contrast to the success Hong Kong had achieved since the start of the global pandemic when it managed to keep the virus largely out through strict travel and quarantine measures. In early 2022 Covid was killing Americans at a rate that was 90 times higher than for people in Hong Kong; when Omicron took hold of the city, the ratio had shrunk to only 3 and a half times higher in the U.S. than in Hong Kong. Over three months Covid killed over 8,300 people in the city, or 1.2% of global Covid deaths, with only 0.1% of the global population.
The Lesson for China
As Omicron started showing up in China, the country faced a similar predicament to Hong Kong but on a much greater scale, of course. While the country’s vaccination rate is relatively high, at 85%, the older population remains vulnerable. According to the journal Nature, through the end of March 52 million people aged over 60 were yet to be fully vaccinated. Worse yet, only 20% of those 80 or older had received a primary vaccination course and booster shot. And while the Sinovac vaccine has showed effectiveness “at reducing severe cases and deaths, the third shot is necessary to confer high levels of protection in those aged over 60.” To put the problem into perspective, there are over 200 million Chinese over the age of 65, including more than 30 million over 80. In March only half of those over 80 had received two doses of the Covid vaccine.
A number of studies that extrapolate the Hong Kong statistics to China based on comparable vaccination rates among the elderly, and which have circulated widely throughout the country, suggest that deaths in the country could top one million if Omicron became as widespread there as it was in Hong Kong. Lu Jiahai, an infectious disease epidemiologist at Sun Yat-sen University in Guagzhou cited in the Nature article suggests the possible number of deaths could be much higher than the widely circulated figure of one million were Omicron to spread through the country’s population. He also very succinctly sums up how the government has backed itself into a corner with its policy errors: “The government is taking responsibility for people’s lives, so it will not change or relax the current prevention and control strategy.” In other words, until vaccination rates are much higher than they are today, especially among the most vulnerable, zero-Covid is likely to remain the got-to policy in China.
What This Means for Investors
China’s zero-Covid policy is likely to continue for weeks, if not months. The government has no other choice because of decisions taken months and years ago. This will continue to disrupt the country’s economy and global supply chains this quarter and possibly into the third quarter. It is likely to put a significant dent in the country’s second quarter GDP number and lead to further market volatility. However, the economic toll the policy has taken on China’s economy in a very politically important year for Xi Jinping will also lead to significant stimulus in the back half of the year. It is also likely to lead to a more pragmatic approach by the government to China’s relationship with the United States and its tacit support for Russia’s invasion of Ukraine. On the stimulus front, the government has begun to outline specific policies such as accelerating big construction projects in the manufacturing, technology, energy, and food sectors. It has also directed local governments to ease restrictions on home purchases and it has put a freeze on a plan to expand a trial it had been running for a new property tax. Most intriguing, though, among the ideas floated so far is the direct issuance of coupons to Chinese citizens to help foster consumer spending. Regardless of whether this is sound economic policy or not, our experience with similar transfer payments in 2020 in the U.S. when most of the country was locked up at home would suggest a massive amount of consumer spending could turbocharge pent-up demand for travel, leisure activities and discretionary spending that could prove to be a boon to the Consumer Discretionary and Services segments of China’s economy. Additionally, the government is expected to increase health care spending significantly to expand doctor and hospital accessibility and prevent a recurrence of today’s dire situation, in which it fears a rampant Omicron surge could quickly overwhelm its health care system.
As the government lockdowns ease and consumer spending resumes, we expect the consumer, health care, and technology sectors to benefit from a bounce in consumer spending and additional government stimulus. Investors in Chinese equities should start looking now at the companies in these sectors in anticipation of a rebound. Our flagship MarketGrader China New Economy Index is currently trading at a median trailing P/E of 18.5, its lowest valuation in almost four years. More than a quarter of its 120 constituents trade at less than 15 times reported earnings while Health Care, its cheapest sector, trades at a median P/E of 15.7.
In addition to some of the short-term stimulus described above, we see two long-term, secular trends that are likely to propel Chinese markets higher in the years ahead, some of which we have written about before. The first one is the continued increase in the share of the stock market’s total market capitalization by private companies and away from State Owned Enterprises (SOEs). Contrary to what many observers think, especially after last year’s crackdown on some of the country’s most prominent private enterprises, we don’t think the government is reversing course in its support for the private sector playing an ever-larger role in the country’s economy and its stock market.
The second long-term tailwind that we find encouraging is the recent launch, after many years of testing and tinkering, of China’s “third pillar” to its pension framework. Fashioned after the Individual Retirement Accounts (IRA) in the United States, this pillar is designed to foster greater market participation by individuals in the stock market and, most importantly, by the institutions that serve them such as insurance companies and asset managers. In the long run this will lead to greater overall institutional participation, lower volatility, and the migration of household assets kept in savings accounts into the country’s capital markets.
We will be publishing a series of articles on these two ‘long-term tailwinds’ in coming weeks as we look beyond the current market volatility in China and ahead to catalysts for the market’s next leg up.
 High Death Rate in Hong Kong Shows Importance of Vaccinating Elderly. The New York Times, March 21, 2022.
 Vaccine used in much of the world no match for omicron variant. YaleNews, January 20, 2022.
 Will Omicron finally overpower China’s COVID defences? Nature, March 20, 2022.
 China’s Xi Pushing to Beat the U.S. in GDP Growth Despite Covid Lockdowns. The Wall Street Journal, April 26, 2022.