Hedge funds are aggressively buying Chinese stocks, betting on a deeper, but shorter Covid setback

Published Thu, Jan 12 20233:00 PM ESTUpdated Thu, Jan 12 20233:19 PM EST

Chinese stocks are looking like hedge fund darlings again as professional traders pile into beaten-down shares on the back of optimism that the world's second-largest economy will successfully reopen. Since the start of November, hedge funds have been consistent net buyers of China equities for eight of the past 10 weeks, according to data from Morgan Stanley. The buying has been so dramatic that the recently acquired positions amount to 70% of what was sold in the first 10 months of 2022, the data showed. After witnessing the massive rebound from the pandemic low in U.S. stocks, hedge funds are betting that the same scenario will play out in China as it tries to return to a pre-pandemic "normal" after ending most Zero Covid controls. The Invesco Golden Dragon China ETF, which tracks 65 Chinese ADRs, has gained almost 17% year to date, and 68% just since the start of November. Since November, 80% of hedge fund buying activity has come from hedge funds adding long positions in China, while 20% was from short covering, Morgan Stanley said. PGJ 6M mountain The Invesco Golden Dragon China ETF To be sure, China has yet to begin to reap the economic benefits of rolling back Covid restrictions, as the infection rate has surged. Investors getting in early on the trade are betting that China's economy will suffer a deeper — albeit shorter —setback. "The exit from the zero-Covid policy has been much faster than expected. Instead of 'flattening the curve,' the policy goal turns out to be 'rushing to herd immunity,'" said Larry Hu, an economist at Macquarie. "Such a dramatic U-turn then implies deeper economic contraction in 4Q22 but also faster reopening and recovery in 2023." On Dec. 7 , Chinese authorities removed virus testing requirements and health code checks for domestic travel. Beijing's previous zero-Covid policy attempted to shield China's 1.4 billion people from the virus, but the policy also limited economic activity and cut off the outside world. Mobility data such as subway passenger turnover and domestic flight travel suggest that China is quickly recovering from the initial shock, according to Hu, who believes that Covid could be in the rear view mirror as early as this March. UBS Global Wealth Management chief investment officer Mark Haefele believes the economic damage from the initial Covid shock will be concentrated in the fourth quarter of 2022 and the first quarter of 2023. "Case numbers are likely to stabilize after the Lunar New Year holiday, and we think a recovery in consumption and activity will begin as early as February, picking up pace from 2Q onward," Haefele said in a note. "We continue to expect GDP to recover to around 5% growth in 2023." The strategist said he favors reopening winners over the next six to 12 months, in industries like consumer, internet, pharmaceutical and medical equipment, transportation and capital goods. Some of the biggest winning Chinese ADRs this year include Dada Nexus , Lexinfintech , Kaixin , and EHang Holdings , which all rallied more than 50%. E-commerce giant Alibaba rallied 28% so far in 2023, while electric vehicle manufacturer Nio climbed 18% "I expect China to see improving growth as the year progresses, and I remain confident it will be a good year," said Invesco Chief Global Market Strategist Kristina Hooper.