In the past few months, sentiment in financial markets has undergone a remarkable shift from extreme pessimism to increasing optimism . While the brighter outlook stems from a number of interrelated factors, nowhere is it more apparent than in China. Beijing’s about-face on its zero-tolerance approach to the Covid-19 pandemic, coupled with the significant relaxation of restrictions in the property sector and signals the crackdown on technology companies has come to an end , have done wonders for China’s image abroad. This is particularly so among investors who were looking for reasons to be bullish on the world’s second-largest economy. A charm offensive by Vice-Premier Liu He at the World Economic Forum in Davos last week fuelled the new-found optimism. After telling delegates that “the door to China will only open up further”, Liu privately met a group of top corporate executives, impressing on them the importance of policies aimed at improving diplomatic ties and boosting growth. According to the Financial Times, the message was “ China is back ”. In markets, the narrative around China is almost uniformly bullish . In a report published on Tuesday, JPMorgan said the demise of the zero-Covid regime meant that “one of the biggest headwinds to global growth for the past two years is ending”. Morgan Stanley, in a note published on January 19, said “Covid management, economic policy and regulatory policy are aligning in a pro-growth fashion for the first time in four years”. There are signs that global funds are returning to China’s markets. Foreign holdings of Chinese bonds rose in December for the first time in 11 months, according to Bloomberg data. Overseas buyers have purchased US$16.5 billion of mainland stocks so far this month, on course for a monthly record. It is not just Chinese assets that are benefiting. The rapid reopening of the economy has been a crucial factor in convincing investors that a global recession is unlikely. According to JPMorgan data, the odds of a recession priced into major asset classes have fallen sharply since October. In the industrial metals market – a barometer for global economic health – the probability of a contraction in output has fallen from 87 per cent to 54 per cent. That the surge in optimism is happening at a time when Covid-19 is ripping through China and infecting about 80 per cent of the population makes the improvement in sentiment all the more remarkable. Herd immunity – a scenario that was almost unthinkable only several months ago given fears of a public health catastrophe – is now viewed by investors as the catalyst for a speedier recovery. Yet, scratch beneath the surface of growing optimism about China and the picture is quite different. Even in markets, investors have yet to put their money where their mouths are. While the narrative around China is bullish, the “China trade” has yet to take hold. JPMorgan notes that “although the worst of [the] outflows is likely behind us”, appetite among global funds to add exposure to China remains tepid. The hesitation stems from several factors. First, it is still early days. Not only are there questions regarding the strength of consumer demand unleashed by the dismantling of the zero-Covid policy – the degree and duration of scarring from nearly three years of self-imposed isolation is unclear – the inflationary impulse from China’s reopening could end up fuelling price pressures across the globe if it stokes demand for commodities. South Asia’s inflation woes set to deepen as China ends zero-Covid policy Second, the optimism generated by China’s reopening is linked to positive developments elsewhere in the world. Markets have been buoyed by signs inflation has peaked , supported by the dramatic fall in wholesale natural gas prices, which has brightened the outlook for Europe. However, it is too soon for central banks to declare victory in the fight against inflation. A “soft landing” for the global economy – the prevailing assumption in markets right now – is by no means assured. Third and most importantly, China’s reopening is occurring in the context of long-standing economic and structural challenges that have been exacerbated by the pandemic. Chinese asset prices might have rebounded sharply, but the economy is in a dire state. The list of problems is long and includes excessive debt , lacklustre growth, increasing income inequality , high youth unemployment and much weaker global demand for China’s exports. The most acute challenge, however, is the crisis in the property sector . While previous measures to force developers to deleverage have been eased significantly and Beijing has made efforts to jump-start stalled housing developments, homebuyers’ confidence that builders will deliver on pre-sold homes has been shattered. Just as worryingly, the relaxation of restrictions – in particular the “ three red lines ” policy of curbing leverage in the industry – could end up causing a further rise in indebtedness. China’s dramatic reopening has triggered an outbreak of bullishness among investors. Given the scale of the sell-off in the past year, there is ample scope for foreign money to pour back in. For this to happen, a strong and durable recovery needs to take hold. Yet, even after China’s rapid reopening, the jury is still out on the strength and durability of the upturn. Nicholas Spiro is a partner at Lauressa Advisory