China’s very public pivot away from Covid Zero late last year was accompanied by a speech from Xi impressing upon top officials the importance of attracting and retaining funds from abroad. Spoken behind the closed doors of the Central Economic Work Conference in December — and only released in full this month — the speech heralded a string of market-friendly reversals for hard-hit sectors like property and Big Tech — as well as a decisive shift in tone from regulators and state media.

The result was a world-beating stock rally in Hong Kong, a record winning streak for Chinese junk dollar debt and the strongest momentum in five years for the yuan. Strategists across Wall Street recommended the country’s assets. One money manager described it as the “easiest” trade in the world, and even long-time skeptics like Morgan Stanley agreed it was time to buy. 

But just two months into 2023, this reopening trade is stalling. Hedge funds who piled into the rally late last year are rapidly trimming risk. Key stock benchmarks in Hong Kong have fallen more than 10% from their January peaks. Bond outflows have resumed. And there’s been little follow through from the steady, long-term institutional players that Xi wants to attract.

New Era

“Most market participants we speak to don’t believe China will return to being a focus the way it was during the pre trade-war era,” said Jon Withaar at Pictet Asset Management. “Ultimately it comes down to visibility — on policy, earnings and geopolitics.” 

Money managers looking for China to rebuild trust are getting mixed regulatory messages from a government that’s snapped its focus back to geopolitics. Superpower rivalry has ramped up to levels last seen in the early days of the Trump administration — and investors are at risk of being caught in the middle again. There’s also a concern that Xi’s greater executive power raises the risk of a policy misstep.

Singapore-based Withaar, Pictet’s head of Asia special situations, said his team decided to significantly reduce its China risk in mid-2021 because of Xi’s moves against tech and online tutoring companies. The Pictet long-short equity fund he manages has kept its exposure to the country low since.

Mistrust of Xi’s government is particularly acute among investors from the US given his consolidation of power in October and pursuit of a “common prosperity” agenda that unleashed the regulatory crackdowns.

James Fletcher, founder of Ethos Investment Management in Salt Lake City, said he’ll be cautious for the next two-to-five years, adding that geopolitical tensions and the government’s heavy hand will continue to be the norm. Such concerns were underscored by recent reports that Xi will parachute in key associates to lead the central bank.

“We are investing in an environment with lower checks and balances and higher consolidation of power, which we think means higher regulatory risk,” he said.

Santa Monica-based Belita Ong, the chair of Dalton Investments, said her firm bought some Chinese stocks late last year after the market’s steep losses, but has divested again.

“Entrepreneurs are being punished for speaking out and creativity is being dampened,” Ong said on Bloomberg TV this month. “Those things make it really hard for us to invest in China.”

The Ministry of Finance recently urged state-owned firms to shun the four biggest international accounting firms, which will further distance foreigners from China’s corporate landscape. And the disappearance of a high-profile investment banker this month has added to the fresh doubts about whether Xi’s crackdown on private enterprise has run its course. 

The saga of the alleged Chinese spy balloon shot down by the US highlights the increasing discordance in Xi’s efforts to woo back investors from countries that are his direct strategic rivals. Soon after the balloon was identified hovering over military installations in Montana, the Biden administration expanded its blacklist of Chinese entities that are banned from buying US goods. 

The number of restrictions on Chinese securities that Americans are allowed to own is also increasing and there is no let up from Beijing in its sanctions of US firms.

All this means that even as policymakers in Beijing take bolder steps to shore up the economy, market confidence remains shaky. There’s a lingering reticence to reallocate to the country in the long-term, revealing just how much damage the traumas of the past two years have done to China’s credibility abroad.  

Hoping for Pragmatism

Karine Hirn at Sweden-based East Capital Asset Management, who saw the value of her firm’s assets in Russia wiped out by the war in Ukraine and the sanctions that followed, doesn’t predict anything similar on the horizon for China.

She’s betting on Xi being pragmatic and making growth his priority. Hirn doesn’t discount the risks though and added that China and global investors were in “unchartered territory” after the regulatory onslaught that began in late 2020.

The key now is “listening to market feedback and being more responsive,” said Patrick Law, who leads Bank of America Corp.’s foreign-exchange trading business in the Asia-Pacific region. “It’s become complicated now — once bitten, twice shy.”

There are some signs that authorities are trying.

The China Securities Regulatory Commission on Feb. 1 sought public feedback on draft rules for new stock listings before rolling them out. It also clarified policies concerning brokerage firms offering cross-border services. And there has been a flurry of approvals granted to global financial firms to fully operate their onshore China businesses.

A lot may depend on the experiences of international visitors who are now back visiting mainland China in significant numbers for the first time since the pandemic, said Sean Debow, chief executive officer of Eurizon Capital Asia.

Strategists at Goldman Sachs Group Inc. are forecasting about 20% price returns from Chinese stocks over the next 12 months, based on the firm’s earnings and valuation forecasts.

Regardless, it will take a prolonged period of calmness on both the regulatory and geopolitical fronts to help rebuild the trust investors need, according to Julien Lafargue, chief market strategist at Barclays Plc’s private bank in London.

“I don’t think this is necessarily going to happen in the short term,” he said. “The healing process will take a very long time.”