Stocks rally on hopes of relief from China’s COVID policy. Here’s why economists think investors are too optimistic.

After a strong sell-off on Monday, driven by fears that civil unrest and China’s total lockdown could fuel global supply chain disruptions, financial markets rallied on hopes of easing in the pandemic policy.

US stocks ended almost flat on Tuesday after the Dow Jones Industrial Average DJIA,
-0.44%
lost almost 500 points in the previous session. The Hong Kong HSI Hang Seng Index,
+2.16%
jumped 2.2% on Wednesday, booking a monthly gain of more than 25%. This is the largest one-month percentage gain since 1998, according to Dow Jones Market Data.

See: Some markets are cheering as China pledges to vaccinate more elderly people. Analysts see positive movement from officials.

However, economists at Capital Economics worry that investors are too optimistic about China’s exit from its zero-COVID policy and believe it won’t happen anytime soon.

“I think the markets have taken a half-full approach to the situation. There are certainly investors who see the bright side of the situation and hope for the end of zero-COVID in the near future,” said Jonas Goltermann, Senior Markets Economist at Capital Economics.

“But it’s not something we think is justified if we’re right that lockdowns continue and zero-COVID isn’t going anywhere. This will eventually filter through and will likely put further downward pressure on the Chinese stock market.

For years, China’s stock markets have offered domestic and foreign investors the opportunity to invest in one of the fastest growing economies in the world. However, Chinese stocks have fallen since the start of 2021 with Hang Seng China Enterprises Index 160462,
+2.21%
down 43.3%. The iShares MSCI China MCHI,
+4.06%
Exchange-traded funds (ETFs) have fallen 46.3% since February 2021, according to Dow Jones Market Data.

Price-to-earnings ratios of China-linked indices and ETFs are at their lowest levels compared to their own history and to other financial markets, particularly in the United States, where valuations are still very high, a Goltermann told clients during a Tuesday briefing.

“I can see where investors are coming from – the Chinese market looks cheap or undervalued relative to the past, (and) relative to its peers. There is a turnaround in COVID that has the possibility of a rebound significant. Now we don’t think that’s warranted and based on a zero COVID outlook,” he added.

Related: China needs at least a year to end zero-COVID policy, experts say

Economists do not believe the country is now ready to open up its economy, although recent updates to its COVID policy that simplify various protocols are a step in that direction. Earlier this month, investors cheered when the government announced changes to its zero COVID policy, which include less time international travelers entering the country must spend in quarantine and more mass testing unless it is not known how infections spread in an area. The changes raised a glimmer of hope that the government was considering easing its draconian pandemic restrictions.

In the best-case scenario, the country will open up in 2023 or 2024, so the rest of the world won’t see any supply chain disruptions, said Mark Williams, chief Asia economist at Capital Economics. . But there is also a significant risk that the pandemic will spiral out of control and the country will have to impose a nationwide lockdown across all industries, which would ripple through global supply chains and commodity markets.

The White House said on Monday that the protests in China had not led to supply chain disruptions.

US stocks opened mostly lower on Wednesday as the updated figure shows the U.S. economy grew at an annual rate of 2.9% in the third quarter as investors awaited the Fed Chairman’s speech Powell at 1:30 p.m. EST. The S&P 500 SPX,
-0.09%
was down 0.3%, while the Dow Jones fell 0.6% and the Nasdaq Composite COMP,
+0.31%
slightly gained 0.1%.