Xi Jinping has been touring China over the past couple of weeks, mask-less and confident. The message is clear: while the rest of the world struggles to overcome Covid-19, China – or, more precisely, the Chinese Communist Party (CCP) - has won the battle with the coronavirus. With the 100th anniversary of the party’s founding looming in July 2021, Xi is personally demonstrating the meaning of "whatever it takes". 

So, whatever the actual situation on the ground in China, investors can count on the authorities to preserve the veneer of stability. Even if there is a serious second wave of infections, Xi cannot risk a catastrophic loss of face by instituting another widespread lockdown.

But while Beijing has the fiscal means and debt capacity - just about - to prop its economy over the next six to 12 months, China's economic and political prospects beyond that look distinctly unpromising.  

A virus that originated in China and turned into a global pandemic in large part because the CCP was slow to contain its spread and withheld information from the World Health Organisation - at best leading the WHO by the nose, at worst influencing its decision-making -  really is the perfect means to deepen and accelerate The Great Decoupling.

More than that. The coronavirus crisis is set to make the necessary fundamental rewriting of the rules of engagement between the existing superpower - America - and the aspiring one - China - that much more acrimonious. Brace for missteps and serious mistakes.

Amid all this uncertainty, there is also one clear long-term investment theme: the bifurcation of the world in two spheres of influence, resulting in the break-up and rerouting of supply chains that will raise costs and lower productivity across the globe. At least as long as two distinctly different ideologies and value systems continue to slug it out for supremacy.  

During the past few weeks, we have tried to reach you all over the phone. We have had numerous fruitful discussions. Even so, as we have still not managed to speak to everyone who expressed interest, I thought it would be useful in this Enodo QuickTake to summarise the key investment themes and risks we see, borne out of our macroeconomic, political and geopolitical analysis.

And, of course, I look forward to as many of you as possible dialling into our regular quarterly client conference call next week. Please send us your questions on all of the issues below. 

China-related investment themes: six- to 12-month horizon

• Go East for relative outperformance - consider the Shanghai Composite against the S&P as a way to take advantage of Beijing's determination to use its equity market and its currency to convey its narrative of stability and superiority

• Bet on old-style China investment plays rather than on consumption ideas related to rebalancing - top-down pressure on SoEs to build anything and everything, alongside ramped-up infrastructure in "new industries", will be the favoured short-term solution to growing unemployment

• As for consumption, certain luxury goods (akin to savings) and essentials should do better than discretionary spending - Covid-19 has only stiffened the headwinds battering China's well-off urbanites. Xi's authoritarian regime was already damaging their wealth and dampening their joie-de-vivre. Now the virus has hit incomes and further raised uncertainty

• Avoid the big banks but take a look at the small number of fledgling private internet lenders - China needs to clean up its bad debts, now made worse by the viral outbreak. We expect substantial bank recapitalisation and consolidation. The big lenders will be brought in to help, shrinking their margins. Private banks, few in number, are better equipped to take advantage of the severe liquidity crunch among SMEs

• For potential outsized gains, find the winners in the sectors now in the throes of supply-side transformation, such as agriculture, financial services, electricity trading and logistics - Early-stage opportunities exist in these areas, as Beijing seeks to address major deficiencies or introduce market forces for the first time. China's trial-and-error approach to marketisation in other sectors has been its most successful development strategy

• Avoid dollar-denominated debt of real estate firms, especially smaller, private ones and those in the residential market rather than commercial and industrial property - while real estate will form part of Beijing’s investment push, Xi remains adamant that "housing is for living in, not betting on”. So do not expect any easing of housing restrictions or support for mortgage lending

• Distressed debt investors should have a look at viable but currently cash-strapped export-oriented private SMEs - Covid-19 has brought to the fore one of the main inefficiencies plaguing the Chinese financial system – state-owned banks don't and won't lend to private SMEs. And even if they wanted to, they wouldn’t know how. The authorities have tried to get banks to lend to SMEs over the past couple of years, so far largely unsuccessfully

• Avoid long-dated government debt but take advantage of higher yields for debt under one year - long-dated government debt is illiquid in China. We see the yuan staying stable or rising slightly against the dollar for six to 12 months. Beyond that, the risks - currency and cost-push inflation - are too high for any onshore debt instrument that has to be held until maturity

• Old-style commodity opportunities could return, but we prefer to look at relative plays like palladium - a few weeks ago we argued that even a feeble recovery in Chinese auto demand (the key incremental demand driver for palladium globally) set against the Covid-19 closure of South African mines (the main global producer) was set to push up the price of the precious metal

Key risks: six- to 12-month horizon

• Cash crunch overwhelming China's SMEs, leading to a surge in unemployment - Beijing's most immediate post-Covid-19 challenge is alleviating the pressure on cash-strapped SMEs, which provide most jobs in China. If its creative solutions fail, expect unemployment to increase further

• Food price inflation/shortages curtailing Beijing's room for policy manoeuvre, perhaps even stoking social unrest - a series of developments has combined to fuel food price inflation. It remains uncomfortably high and could rise further. African swine flu killed 40% of China's pig herd in 2019, and a return to normal is not going to happen any time soon given the coronavirus pandemic. Hubei, the province hit hardest by Covid-19, is also the largest producer of fertiliser, potentially restricting the spring planting season. China's grain stocks are massively overstated, judging by Beijing’s 180-degree turn on ethanol policy this year. Moreover, the global supply/demand balance is deteriorating. Some countries have responded to Covid-19 by restricting food exports - Vietnam and India have suspended rice shipments – while plagues of locusts are destroying crops in east Africa and Pakistan

• Political risk - Covid-19 is the biggest political challenge to Xi since he took power in 2012. Depending on how the CCP navigates the treacherous waters ahead, it could yet turn out to be China's Chernobyl moment. While not our central case, the risk of an intra-Party coup or a significant shift in political direction is now higher than it has been since the Tiananmen Square massacre. Any change is unlikely before the Party plenum expected in the autumn

• The Great Decoupling - Covid-19 has strained Sino-US relations further. Looking past Trump's bluster, a dangerous escalation is unlikely in the very short term while the US is battling to contain the viral outbreak. But it cannot be ruled out. In the meantime, the CCP is acting tough at home and in Hong Kong and is keeping up the pressure on Taiwan. As November’s US elections draw near, the higher the risk that Trump will roll out measures that could spook markets. American-based investors in particular should consider carefully whether they want to enter China's financial markets at all. Meanwhile, China has finally opened the door of its financial sector wide to foreign investors. You can listen to Enodo's Fraser Howie discuss how its idiosyncratic markets work, why investors can't avoid them any longer, and how you should approach investing in onshore assets

China-related investment themes: two- to three-year horizon

I'll discuss how to position your investments during The Great Decoupling over the next two to three years in another report. But let me briefly flag two longer-term investment conclusions and one key risk:

• Avoid Chinese equities, bonds and the yuan on a two- to three-year horizon - China's development model is facing its sternest test. The authorities are running out of time to implement viable supply-side change and to arrest a dangerous debt spiral. The international environment is also much more hostile. Not only the US but also the EU and India are pushing back against China

• Reshoring is likely to offer investment opportunities in both the US and Chinese spheres of influence - check out our report introducing the Enodo Reshoring Index detailing which US sectors are likely to benefit from production returning home

• Watch out for the third, and most dangerous, aspect of The Great Decoupling: Taiwan War - having always viewed the Tech War as almost a certainty, we have recently changed the probabilities on both our Trade War and Taiwan War timelines. We now also see the Trade War as a near certainty and have raised the probability that a military conflict between China and the US over Taiwan (or another issue) will not be avoided by 2022 to 45% from 40%. See the infographics below