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Max Geopolitical & Macro Uncertainty in Q1.

Jacob and Roger explain why the uncertainties around the Russia-Ukraine War and China's Re-Opening should make investors extremely conservative in Q1

We'll be hosting an Ask Me Anything Session on Twitter on Feb 6 at 2 PM Eastern / 7 PM GMT so that readers can ask follow-up questions about this piece to Jacob and Roger. Make sure to tune in!


by Jacob Shapiro

Let’s cut right to the chase. The thesis of this piece is that geopolitical uncertainty in Q1 2023 is too high to make high-confidence projections about two critical factors driving markets: the ongoing Russia-Ukraine war and China’s COVID-19 reopening.

This may feel like a weak-sauce thesis, and perhaps it is. The whole point of paying attention to a specialist is their differentiated expertise, especially considering that geopolitical uncertainty is always high. When the purported expert throws his or her hands up and says, “Better to be cautious due to elevated uncertainty,” the expert risks losing his or her audience, as it certainly does not take a decade’s study of geopolitics to utter the words, “I don’t know.”

Still – there is nothing a responsible geopolitical analyst can say with a high degree of confidence about Q1 right now given how uncertain the environment is around two key events that are likely to have a dramatic impact on asset prices, and I’m not in the business of forcing a prediction when I don’t have the necessary conditions to have one.

  • Geopolitical methodology performs its best over longer time horizons, when the fundamentals and more static variables it emphasizes assert themselves over the vagaries of markets and domestic politics. The shorter the time horizon, the more critical the task of combining geopolitics with other disciplines, whether market analysis, open-source intelligence, or economics.

  • A tangible expression of this catch-22 is that geopolitics is good at making discrete predictions over longer time horizons. A geopolitical forecast at the 5-year level can appear surprisingly prescient in hindsight. It is irresponsible to attempt discrete forecasts over shorter time horizons when geopolitics becomes subject to other extremely powerful forces at work. That is why any decent geopolitical analyst relies on scenarios rather than predictions for a period as compressed as Q1 2023.

Scenario analysis is exactly what it sounds like. It involves generating a spectrum of possibilities – i.e., identifying everything that is theoretically possible – for a specific topic or event. (In the immortal words of Sherlock Holmes, “When you have eliminated all which is impossible, then whatever remains, however improbable, must be the truth.”)

From there, variant situations are crafted and rough probabilities for those situations are assigned based on how certain one is about the information at one’s disposal. Finally – and most importantly – negative signposts are assigned to each scenario.

  • An unfalsifiable scenario is not a scenario – it is a work of fantasy.

  • Scenario analysis is a helpful tool not necessarily to get things right (though of course, that is preferable), but rather to identify a framework that helps one be the first to realize when something is wrong.

The reason that this analyst approaches Q1 2023 with such trepidation is that the scenario analyses for the Russia-Ukraine War and the China COVID-19 reopening are fraught with uncertainty and highly contingent on intangible variables. There are few market fundamentals or concrete variables available to help generate even a modicum of analytical certainty.

That’s the bad news. The good news is that by Q2 2023, there should be significantly more clarity about these two geopolitical albatrosses.

1. Ukraine will be through the worst of the winter and the spring muddy season – at which point there will be much more data available to benchmark whether the war is going to escalate or will trend toward stasis.

2. In China, COVID-19 will have burned through much of the population and we’ll have visibility on whether or not the strain on China’s healthcare system is going to challenge the legitimacy of the Chinese Communist Party.

Remember: Geopolitics is not an objective force. It is a methodology for understanding relations between nations. Geopolitics should never tell you what to think – if it has, it has gone off its methodological rails. Geopolitics directs you on how to think, and over the next 3 months, it’s directing you to pay careful and humble attention to the Russia-Ukraine War and the China COVID-19 situation, and to be ready for a range of possibilities so that once better data is available, you can be among the first to react.

Russia-Ukraine War

The pace of the Russia-Ukraine War has stalled. Although global headlines are fixed on the battle for Soledar, a small town known for its salt mines (as of this writing, Russia has claimed the conquest of Soledar, while Ukraine rejects this and asserts it is counterattacking Russia’s attacks), compared to the scale of the war for most of 2022, the battle for Soledar is small and the victor will not gain a significant strategic victory by holding the town.

The reason is relatively simple: it is winter in Russia and Ukraine, meaning it is a bad time for large-scale, land-based warfighting. The worst time will be in a month or two, when the frozen ground begins to thaw and mud makes it difficult to move tanks and other armored vehicles quickly or easily from one area to another.

Most of the fighting right now is tactical and about positioning for the next phase of the war. Russia is licking its wounds from its disastrous performance thus far – but it is also attempting to mobilize additional forces, bring critical materiel to the front, and prepare for the kind of drawn-out slugfest Russian armies have won in the past. Ukraine’s urgency for acquiring weapons and ammunition from the West is palpable because Ukraine must assume Russia is neither aiming for a truce nor on the verge of collapse. Ukraine’s leaders have also clearly stated their desire to take back all their territory – to return the borders to where they were before the 2014 Ukrainian Revolution.

There are three possible scenarios for what will happen next. The odds of them materializing are broadly almost equally split, with a very small tilt towards scenario #1 being the most likely.

  1. Re-intensification of conflict in Spring with Russia seeking to consolidate positions and conquer territory and Ukraine attempting to retake land. This scenario is inclusive of victory for either side or ongoing stalemate. It could end with Ukraine taking back all its territory or it could end with Ukraine’s defenders collapsing. It could even end with Russia deeming Ukraine’s attacks on recently annexed territories as an attack on Russia – which in turn could trigger the use of nuclear weapons. Each of these sub-scenarios comes with its own consequences, but the broader scenario – a re-intensification of the conflict – appears the most likely at this juncture, though remember, we are operating with low confidence intervals. It also has the most potential for disrupting global agricultural and energy markets (with prices moving another leg higher). 35 percent probability

  2. A frozen conflict takes hold. This would be a 2014-style scenario where current gains are locked in and low-level conflict continues. From a practical standpoint, this would mean things do not get worse – but also that they do not get better. From a market standpoint, the Russia-Ukraine war will have been priced in and moved to the rear mirror. After all, what role did the frozen conflict between Russia and Ukraine in the Donbas play in global markets from 2014-2022? (Rhetorical question.) This scenario implies that the war will become a smaller driver of asset prices going forward. 32.5 percent probability

  3. A peace agreement emerges, either because Ukraine’s allies pressure Kyiv to the negotiating table, or because the Kremlin – whether because Russian President Vladimir Putin realizes he is fighting a battle he can’t win, or because Putin is removed by Russia’s oligarchy or military and replaced with a new figurehead who can mend relations with Ukraine and with the West – sues for peace. Until December 30th, this scenario seemed like fantasy – but then the Russian government quietly cleared foreign currency settlements from unfriendly countries for purchases of Russian natural gas supplies. (Of course, Moscow bombed the shit out of Kyiv just a few days later – but remember that’s the point, there is no certainty to find here!) This scenario could mean a sharp fall in global grain, fertilizer, and energy prices, and it could also open the door to the rehabilitation of the bilateral relationship between Russia and Europe. 32.5 percent probability

Here is a banal and trite truth: war is really hard to predict. An errant missile or vigilante commander at the wrong place and at the wrong time can change the course of history. It is why analysts like me hate war – not just because of the tragic and unnecessary loss of life, but also because predicting war is so difficult, and so dependent on variables that are impossible to measure. One of the most important variables driving the Russia-Ukraine war, for example, is the psyche of Vladimir Putin – something that no one has access to. Another is the stamina and resilience of the Ukrainian people – qualities that were sorely underestimated by both the U.S. and Russia in 2022.

By the time the weather improves, and the Ukrainian soil is fit for fighting once more, we will have sufficient clarity over which of the above scenarios is emerging (or if something unexpected is lurking behind the fog of war). That, in turn, will allow more educated theses about things like the price of commodities like soil and wheat, and the extent to which the war will spur the European Union toward the types of policies that will make it more cohesive and competitive in the years ahead (mostly referring to securing a healthy energy supply chain). Until then, anyone who tells you they know what is going to happen next is either basing their analysis on tarot cards… or has direct access to Putin’s psychiatrist. (And if it’s the latter – give us a call!)

COVID-19 Reopening in China

China kept a lid on the COVID-19 pandemic longer than any country in the world. China did not do this as part of a conspiracy to drive up inflation in Western countries, nor were China’s draconian lockdowns an expression of a totalitarian bent in the Chinese Communist Party (CCP). China’s reasons for maintaining lockdowns long after most countries gave up on them was because Beijing felt the risk posed by the spread of the virus was greater than the economic and social costs of lockdowns.

Think about it this way: China is a country with over 1 billion people. It is also a society that places a premium on the reverence of its elders. From roughly 1980-2015, the Chinese government maintained a One Child Policy, which means Chinese Gen Xers, Millennials, and even some Gen Z grew up as only children. China’s healthcare system is not particularly good, and due to the U.S.-China trade war, China’s access to cutting-edge mRNA vaccines and COVID-19 treatments is limited. China’s biotech sector has proven unable to create vaccines and treatments that offer equivalent protection as those manufactured in the West, and, for all the CCP’s power, it has failed to get shots of more effective vaccines into Chinese arms (vaccine skepticism, it turns out, is not the sole province of the West).

Chinese President Xi Jinping’s cost-benefit analysis was clear:

  • He could humiliate himself and his foreign policy agenda and gain access to foreign vaccines.

  • He could let the virus run rampant, which would presumably overwhelm China’s healthcare system (see the documentary 76 Days for more on what this would look like) and could generate a popular backlash so fierce that it would jeopardize Communist rule.

  • Or he could use the virus as the reason behind draconian lockdowns, during which he would consolidate his power and attempt to force-feed supply-side reforms down the Chinese economic system’s throat.

Xi opted for door number 3 – and it worked for a shocking 2+ years. But the Chinese people are human and being locked in a cage is not a natural state of being. The spark behind the Chinese turn against COVID-19 did not have to do with the lockdowns perse – it began with protests over declining real estate prices and the attendant stress on Chinese property developers and middle-class Chinese savings. Quickly, however, popular grievances over the lockdowns clearly emerged all while more contagious variants made China’s controls less effective. For China to remain in a Zero-COVID world, it would have had to crackdown even more strictly on a population that was already showing signs it was at a breaking point.

Note: That China has reversed course on its Zero-COVID-19 policy is a good macro indicator for China in the long term. When Chairman Mao tried to make China agriculturally self-sufficient in the 1950s, no one told Mao how badly his reforms were going, and the result was millions of people died in a manmade famine because Mao was too inflexible to change policy. Xi’s about-face on COVID-19 suggests he has not yet fallen into the kind of self-delusion that Mao did in the 1950s (or that Putin did when he decided to invade Ukraine last year). The Chinese state is responsive to change and flexible enough to realize when it is in trouble.

Even so, the months ahead are very uncertain. Here are three scenarios that capture the spectrum of possibility going forward.

1. Vietnam in July 2021. Vietnam, like China, is a Communist country that opted for harsh lockdown measures after the pandemic surged around the rest of the world. For a while, this made Vietnam a global darling (harsh lockdowns = they kept COVID-19 under control = their factories kept humming the whole time), as every company wanted to relocate supply chains there. Vietnam’s policies, however, were not up to the task of the increased contagiousness of the Delta variant. As a result, supply chains in Vietnam ground to a standstill for months. GDP declined in Q3 2021 by over 6% – and only reached the previous quarter’s growth rates in Q3 2022. Vietnam survived – but for companies with Vietnam exposure, the country was a mess for at least 2-3 months, and Vietnam struggled to rev its economy back into gear. This would imply an underwhelming economic outlook for the next quarter or two, which would put a break or even reverse the recent rally in Chinese stocks. 50 percent probability

2. China’s population is ready to rock n’ roll after almost 3 years of continuous lockdown. This is a mega re-opening play on steroids, especially as the CCP now has pivoted to identifying its real estate bubble and low growth rates as a bigger threat to regime stability than COVID-19. Pent-up demand combined with demand-side stimulus would create a massive bull market for commodities. On the supply side, China’s emphasis on growth, while ephemeral, could lead to better trade relations between China and the U.S., as the former is willing to compromise on issues in order to get growth humming again once more. (For what it is worth, this feels like the consensus view right now, and while it is possible… it is not the only possibility, and it is not self-evidently the most likely.) 45 percent probability

3. COVID-19 is about to get 1 billion new hosts to infect and mutate in. A new variant or mutation could emerge that is even more contagious, or, in a worst-case scenario, deadlier, with cataclysmic consequences not just for China but the world. China’s subpar health care system will result in deaths in China rising into the millions. Angry and heartbroken Chinese people will struggle even to bury the victims of the pandemic and their rage will be directed at the CCP, which has touted Beijing’s COVID-19 policies relative to the rest of the world for years, and which Xi Jinping has tied even some of his personal legitimacy toward. Note: China’s healthcare system – at least based on the inadequate amount and quality of data China is sharing with the world – appears to be holding up right now despite being in the throes of a massive COVID-19 wave. That is a positive sign that a doomsday scenario is becoming less likely. 5 percent probability

There is no geopolitical model for how the virus will mutate or how the Chinese people will react to the positive and negative side-effects of such swift reopening. (No country has experienced the extremes China has – from draconian lockdowns to such liberal openness. This is true of China in so many ways – it is a country of extreme experience.) The most likely scenario is the Vietnam scenario – but China is more than 10x the size of Vietnam and mired in the initial stages of a great power competition and an escalating trade war with its top customer. If Chinese leaders were so terrified of the potential threat posed by COVID-19 that they locked the economy down for 2+ years… investors should be just as cautious.

Key takeaway of all of this is: now is not the time to be adding risk, so play it conservatively and stick with the things you know well for at least the next couple of months.


by Roger Hirst

Max Macro Uncertainty

Confidently forecasting the economic and market outcomes for 2023 is a tricky proposition because of the vast array of divergent, but equally plausible outcomes. Investors will therefore have to stay nimble and avoid getting stubbornly attached to a specific narrative (this might mean less Twitter for some of us).

All the following scenarios have the potential to materialize in 2023:

  • A deep recession or no recession

  • Sticky inflation or deflation

  • A tight labor market or a surge in unemployment

It may simply be a matter of time horizon and sequencing. For instance:

  • If a recession quickly unfolds in the first half of the year, then policymakers may be able to pivot quickly.

  • If employment remains tight (and wages inflationary), policymakers may need to keep tightening.

We can therefore build both a bullish and a bearish thesis for risk assets based on these two wildly different pathways.

Risk management is always more important than risk-taking, and in 2023, this will be doubly so.

Additionally, for 2023, geopolitical outcomes will have significant ramifications for financial markets. In fact, that’s why Jacob focused his research on the two risks where ‘uncertainty in Q1 2023 is too high to make high-confidence projections’, namely:

  • The ongoing Russia-Ukraine War and

  • China’s COVID-19 reopening

Whilst these are obviously key geopolitical narratives, why should investors care about them? Because in 2022, policymakers in the US and Europe switched their focus to capping prices, from policies that previously supported growth, and both the Ukraine War and a re-opening of China’s economy have direct implications on this:

  1. The Russia-Ukraine War has specific implications for energy prices, particularly their impact on Europe (the longer the conflict goes, the worse for Europe). The odds seem to be stacked against Europe for now - Jacob outlines three scenarios, two of which could prolong the energy crisis, which is why I worry that warm winter weather in Europe may have created a false sense of short-term security.

  2. China’s re-opening is expected to revive demand. But what matters for global investors is whether China’s reopening is inward or outward looking. Will they return to the ‘growth-at-any-cost’ model, or will they continue the nascent transition towards sustainable growth that arguably started in 2017-2018? Both of these scenarios have significantly different implications for commodities.

The Russia-Ukraine War: A European Perspective

Europe is a net importer of its energy needs. This is not an evenly distributed requirement, meaning that some countries have access to their own resources (notably Norway), whilst others have a relatively diverse mix of energy sources already (e.g. Spain). Germany’s reliance on Russian sources of natural gas, on the other hand, has become the poster child for energy insecurity.

Not all of Europe’s energy issues, however, were made in Russia. Even before Russia’s invasion of Ukraine, electricity prices had surged due to reliability problems across ‘sustainable’ sources of energy, such as wind and solar. The first spikes in energy prices occurred at the back end of 2021.

After the EU agreed to wean itself off Russian sources of energy as a response to the invasion of Ukraine, the gyrations in energy prices accelerated. The summer of 2022 was punctuated by fear of energy shortages that at times bordered on hysteria. Some analysts promoted apocalyptic visions of Europeans huddled around open fires whilst the industrial heartlands shuddered to a standstill.

The worst-case scenario, however, was averted. Storage tanks were refilled before the Nordstream 2 pipeline was ruptured (meaning that any potential future détentewith Russia would not help Europe’s energy cause in the short term). Policymakers dug deep, promising to do whatever it takes to keep the electricity flowing (for those who can afford it, there are nearly always sufficient sources of energy). But then climate, for a change, gave Europe something to cheer about as the end of 2022 was, for the most part, historically mild.

But was the energy crisis averted, or merely postponed? The unseasonably warm climate was an unexpected dividend, but Europe has not yet implemented a long-term solution. Indeed, if temperatures turned lower for the second half of the winter season, energy resources could still be stretched.

Europe’s Dilemma

We know that two of the three scenarios outlined by Jacob imply a prolonged conflict:

1. Escalation

2. Stagnation

In both scenarios, sanctions would remain, and Europe would still have to diversify its energy requirements. Even if there was a de-escalation, Europe would still want to invest in long-term energy security (at least, we would hope so). Energy diversification is not a simple switch from one source to another. It requires the build-out of an infrastructure (e.g., a replacement of Nordstream capacity) that is both robust and secure.

Until that has been completed, Europe will pay a premium for its energy requirements, whilst increasing Capex on the infrastructure that will deliver it. Luck may be on Europe’s side, but price dislocations will never be far away until a full transition has been completed.

This will be a multi-year undertaking.

The third scenario that Jacob outlines is the one in which “a peace agreement emerges”.

‘This scenario could mean a sharp fall in global grain, fertilizer, and energy prices, and it could also open the door to the rehabilitation of the bilateral relationship between Russia and Europe’.

Jacob points out that ‘until December 30th, this scenario seemed like fantasy’. European equity markets, however, have been performing as if this is the base case. Admittedly, other factors have been in play, notably:

  • The dollar declined sharply from its peak (helping loosen financial conditions)

  • Global inflation appears to have peaked

  • The recessionary outlook has moderated

Are European Equity Markets Too Optimistic?

Even though inflation may be moderating, and growth may not decline as much as anticipated, it may still come as a surprise that the headline French equity index, the CAC, is barely 5% off all-time highs. Admittedly, France is better equipped to deal with energy adversity due to her nuclear and hydropower, but she is not immune.

If Germany is at the epicenter of both the (potential) energy crisis and the decline in global demand (Germany is an exporting nation), it may be equally surprising to see her headline index, the DAX, just 7% off the highs.

German electricity supply remains volatile. One-month baseload prices may have declined from the peaks, but they are still double where they were before 2021.

The UK’s FTSE100 is at all-time high levels. The index benefits from a sector bias towards oil and commodity stocks, but it’s showing no inclination to price for a potential global recession. The FTSE100 is, however, just as susceptible to gyrations within the energy market, with many of its operations located internationally, including in greater Europe. Within the UK, December experienced near-record prices for ‘next-day’ electricity, which obviously also implies that FTSE’s companies with domestic operations are also exposed to energy uncertainty.

European equities may recently have benefited from the repatriation of capital out of the US (the latest BoA Survey showed that managers are underweight the US by the largest amount since 2005), but European economies are far more vulnerable to ongoing dislocations in the energy markets. The US, on the other hand, is relatively self-sufficient.

Many of Europe’s major equity indices are also exposed to global growth (via exports). The declining dollar and falling inflation levels may have provided a short-term boost to growth prospects, but if the US falls into recession, then global markets are unlikely to emerge unscathed.

In recent weeks, European equities have benefited from peak inflation and potentially a peak dollar during Q4 2022. The peak in the energy crisis may also be in the rear-view mirror, but that does not mean that the energy crisis is over. Europe may still have to pay a premium for its energy needs, which translates as a tax on consumers and as margin compression for producers.

Are Options on the FTSE a Cheap Hedge?

Investors can play the downside risks through the options markets on the FTSE100. Implied volatility has fallen to 13% (anywhere close to 10% is getting low) and at the close on Friday, Jan 20th, the FTSE100 Jun 16th 2023 95% put cost around 1.95% (indicatively). Currently close to all-time highs, the index has fallen between 35% and 50% during the last three recessions, whilst implied volatility has exceeded 50% on those occasions (so volatility is cheap and the index is still close to all-time highs with large historical drawdowns during recessions).

Some investors have been considering the June 2023 95% put for a cost of around 1.8%. Will the UK equity market avoid the depredations of a global recession or a European energy crisis? That would be highly unlikely, which is why this trade caught our attention.


  • Recession is still the base case for 2023.

  • The European energy crisis has not been cancelled, only postponed.

  • Whilst the outcomes of the Ukraine war are uncertain, two of the three most plausible scenarios suggest that energy risks remain elevated during this period of economic uncertainty.

  • With volatility falling to ‘bull market’ levels on some indices, the options market may offer an attractive way to hedge both geopolitical and economic risks.

COVID-19 Reopening in China: But Which China will Reopen?

China has been COVID’s longest stop-start saga. For many analysts, China was expected to bounce back from lockdowns in 2022, only for restrictions to remain draconian for way longer than expected, all whilst tech and real estate suffered from regulatory pressure.

Rumors of a reopening began to circulate in H2 2022, and this has helped the equity market bounce off its long-term support, which appears to be a red line for policymakers.

The repricing of China’s equity markets for a re-opening started in Q4 2022. As with Europe, however, some of this relief rally was attributable to the worldwide rebound that was set in motion by the reversal in the US dollar (a loosening of financial conditions) and a presumed peak in many global inflation metrics.

Emerging markets have profited from an anticipated policy pause by the US Federal Reserve. If global markets have already benefited from this loosening of global conditions, can global markets benefit a second time from a true reopening of China’s economy?

This will depend upon the type of China that reopens. Of the three scenarios that Jacob identifies, it is scenario #1 (Vietnam style) that he considers to be the most likely. For global investors, however, it is the likelihood of scenario #2 (‘the mega re-opening on steroids’) that has the most significant implications, because it would reverse China’s push towards stable growth that was being implemented at the end of the last decade.

The following section is an extremely simplified outline that contextualizes China’s attempt to shift gears towards the end of the 2010s.

The Timeline to Re-Opening: 2000-2018

After China’s entry into the World Trade Organization in 2001, the growth model can be (over) simplified as follows:

  • Produce goods for export

  • Spend the revenues on fixed asset investment (infrastructure)

  • Supercharge that development with credit growth

This model brought an astonishingly rapid pace of development that initially supported the outperformance of the emerging market and commodity complex until the Great Financial Crisis (GFC) in 2008.

After the GFC, China’s primary growth lever was the liberal application of credit injections whenever the global engine of growth started to falter. China’s credit impulse (the change in credit as a percentage of GDP) supported global growth on numerous occasions:

  • After the GFC

  • During the depths of the European debt crisis

  • After the commodity and industrial profits recession of 2015

  • After the Covid Crisis

Global investors became fixated on the potential for commodities and resource stocks to outperform on the back of China’s influence. In layman’s terms, this would mean they’d look at the credit impulse change, and correlate it with commodities performance.

This became a theme during the run-up to the GFC and remained top of mind until 2017/2018 when many investors were caught wrongfooted by China injecting credit, but without resources taking off again. In fact, despite supply-side constraints and all the worries about oil deficits, the 2008 highs in oil prices have still not been bettered.

Profligate use of credit and excessive fixed asset investment (FAI), however, was not without its drawbacks. Excess credit meant that many infrastructure projects were built on the shaky foundations of debt and leverage, which would prove to be problematic once the rate of change of Chinese growth started to naturally decline:

  • GDP growth should always start to decline once an economy has passed through its ‘emerging’ phase.

  • For China, GDP growth peaked in 2007 and has been steadily declining from 12% in 2010 to 6% just before COVID.

In the aftermath of the global industrial profit recession of 2015, credit injections helped to sustain the bubble in real estate but did little to help the bloated state-owned enterprises (SOEs), many of which were creaking under excessive debt burdens.

The Timeline to Re-Opening: 2018 – COVID

By 2018, fixed asset investment had peaked in nominal terms.

Policymakers wanted to steer a new course, away from ‘growth at any cost’ towards a sustainable path, where credit would be targeted at specific sectors that needed support, rather than a scatter-gun approach that invariably fueled the excess in the property sector.

But the global investment community was still fixated on the 6.5% GDP growth that policymakers had targeted (and has since been revised lower). Global investors have to understand that 6.5% Chinese GDP growth focused on fixed asset investment (pre-2018) has very different implications for global investors than 6.5% GDP growth aimed at sustainable domestic growth (post-2018).

Case in point: exporting equity indexes of heavy industry exporting countries such as the Korean KOSPI and DAX struggled with this change of direction in 2018.

This was the path that China was navigating before COVID struck, which subsequently forced policymakers into a necessary U-turn. The question for global investors now is:

  • Will China restart the transition of 2018 (sustainable domestic growth) or will they return to the pre-2018 landscape of ‘export and build’?

The Timeline to Re-Opening: COVID – Present

China’s initial foray down the path towards sustainable growth was suspended due to the exogenous shock of the COVID crisis.

  • The western response was demand-side policies that supported wages and income, which directly contributed to the above-trend demand for finished goods that helped fuel a surge in inflation.

  • China chose to pursue supply-side policies that focused on exports, which Jacob argues had the additional benefit of helping Xi ‘consolidate his power’ and ‘worked for a shocking 2+ years.’ One of the benefits was that China never saw the surge in consumer prices that had infected many western economies, where demand had been supercharged by demand-side policies.

This period, however, also saw reforms that eviscerated the market for technology stocks. This was part of the levelling up process - taking the excesses out of tech and real estate to spread the wealth. The US-listed KraneShares CSI China Internet ETF fell over 80% from peak to trough.

Simultaneously, policymakers were also attempting (unsuccessfully) to deflate the property bubble, which Jacob argues is one reason why Chinese popular sentiment began to sour, forcing policymakers into a U-turn over their COVID policy.

The Outlook for Re-Opening

Will China turn its back on the transition to a sustainable economy? To do so would involve pursuing the second re-opening scenario that Jacob identified: ‘the mega re-opening play on steroids.’ If this outcome were to occur, it would indeed be a positive for global growth stocks and commodities in general. It would also benefit large swathes of the emerging markets that form part of China’s extended supply chains- that would be Brazil, Chile, most of the Belt and Road countries, and any suppliers of raw materials like Australia.

This is the outcome that global markets crave, but I would agree with Jacob when he says,

‘For what it is worth, this feels like the consensus view right now, and while it is possible… it is not the only possibility, and it is not self-evidently the most likely’.

The property and tech sectors have been the source of extreme inequality within China. Reducing these inequalities has become a focus for President Xi and his hand-picked support base in the upper tiers of the communist party. Whilst the experiment with controlled deflation of the property bubble may now be on hold, we shouldn’t expect attempts at all-out reflation of this sector either. That would simply exacerbate the issues that had been creating extreme inequality (and instability) in the pre-COVID years.

Leadership in Innovation

A supply-side focus (i.e. a return to post-2018 reforms with goals like becoming leaders in green tech, for example, rather than simply building infrastructure) should help China deliver on commitments to become a world leader in sectors such as green technology and 5G networks. Whilst these are still resource-intensive businesses, the rate of change of demand growth cannot match the years in the immediate aftermath of its entry into the WTO.

China’s population is also peaking, with 2022 being the first year in 60 years where its population actually contracted. If runaway credit (credit growth that is significantly higher than GDP growth; runaway credit is usually comparable to excess leverage) is again allowed to bloat the property sector, the next come-down could be even harder to control if demographics are also deteriorating. There are few incentives for China’s leaders to supercharge property, outside of a short-term fix.

If Chinese households are sitting on excess savings, built up during the pandemic, then we should expect the post-lockdown surge to focus on services (travel, restaurants, etc.) rather than goods. That would have a domestic, rather than international, focus, meaning that the bull case for commodities would look less enticing.

Whilst we can observe China’s credit impulse rising once more on a year-on-year basis (this usually leads global liquidity by 12 months – see above), in absolute terms this has been an anemic injection, more akin to the transition of 2018. The impulse is up, but not powerfully so.


  • Although we cannot know which type of re-opening China will pursue, it is unlikely that they will fuel the demand surge in commodities that global investors are hoping for.

  • China’s policymakers will still aim for high levels of GDP growth relative to global peers, but 6.5% GDP growth today (for example) should have a very different impact on global markets compared to 6.5% GDP growth before 2018.

  • A re-opening of China’s markets could, in fact, help to ease pressures in the supply chains of finished products at a time when US consumers have already switched from goods to services.

  • Whilst China’s domestic demand for energy may accelerate, the bigger energy risks are exogenous to China. Higher global energy prices could result from a global economy that remains resilient for longer than expected, rather than from the marginal effects of China’s re-opening itself.

  • Investors should therefore focus on the domestic Chinese market, rather than anticipate a 2000’s style return to credit-fueled excess that drives aggressive outperformance in global commodities and cyclical stocks.

A reminder: 

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