Once the situation normalises, we believe investors will be presented with interesting entry points, allowing them to benefit from secular sustainable returns.
Here is the view from our China equities team.
1. Despite China being the epicentre of the virus, how do you explain the recent rebound in onshore equity indices and the surge in inflows?
The rebound and inflows after the extended Chinese New Year holiday were initially led mostly by investment coming from national team money and insurance companies. Investors now appear to be regaining some confidence in equity markets with the outbreak looking more contained in China (outside Hubei province where it originated).
Exhibit 1: Chinese equity markets saw a slight rebound earlier in February before correcting again; trading is likely to remain volatile ahead of company earnings reports on the first quarter - graph shows the performance of onshore and offshore markets (in USD; Dec 2019 = 100)
2. What is different this time compared with the SARS outbreak?
The global impact of the economic slowdown in China is much bigger today than it was 17 years ago during the SARS crisis given China’s bigger share of the global economy, global trade and global oil demand. However, any economic damage might be contained because Beijing has relatively quickly taken firm measures; medical care is better; and online shopping supports overall retail sales.
3. What could be the impact on growth prospects and company earnings?
If the situation starts normalising by March, we estimate the negative impact on corporate earnings to be 20-30% (excluding financials) for Q1 2020 (vs. initial estimates). Although Q1 2020 economic growth is expected to be severely impacted, we expect the downside risk to full-year growth to be manageable. The combination of stabilised trade tensions, the recovery in global industrial activity and the room for greater fiscal support should allow for a reacceleration of growth.
4. Will the authorities ease monetary policy aggressively to sustain economic growth?
In contrast to SARS in 2003, we believe that the Chinese authorities are taking firmer actions, locking down cities and issuing warnings against travelling to Wuhan. We expect China’s monetary easing and fiscal policies to continue to support economic growth in a calibrated manner (e.g. more interest rate cuts in the lending facilities, more infrastructure spending). Overall, there could be a further delay in the deleveraging process. We may expect more policy support for the consumption sector. For now, we do not expect a significant loosening of housing policy.
5. When do we expect the epidemic to peak?
According to big data analyses, the outbreak is expected to fade in March. If this were so, the economic damage would be limited to Q1. Restarting production will be gradual as most cities are still controlling worker inflows strictly. If the number of newly confirmed infected cases in China (outside of Hubei) does not pick up, we can assume the virus is largely under control.
6. What are the key risks in 2020?
The key risks include a longer-than-expected duration of the outbreak (due to Chinese workers returning to work and infection cases rising globally); US-China trade tensions escalating; less fiscal support than expected from Beijing; and rising credit defaults in China.
7. If there were further downside risks, would you see entry opportunities?
Further market falls may create buying opportunities for investors looking for longer-term returns in Chinese equities. Valuations of both China A and H shares look undemanding. Also, given that foreign inflows quickly resumed in May 2003 after SARS was brought under control, investors will be keenly watching for the turning point in the number of new infection cases.
8. Which sectors will lose/benefit? Will the virus lead to longer-term changes?
Retail sales and travel are likely to be most impacted during Q1/Q2 2020, while e-commerce, IT, mobile games or healthcare should benefit the most. This outbreak should accelerate the digitalisation trend (online working, online education, online entertainment) across many businesses.
9. What is your view on positioning in the near term?
We favour the technology, healthcare, consumer sectors and selective macroeconomically driven industries such as cement.
10. Where do you see long-term investment opportunities?
We see opportunities related to these three structural trends: technology/innovation, consumption upgrading, and industry consolidation.
We are upbeat on Chinese equities for a number of reasons: a still-benign profit growth outlook, reasonable valuations, as well as constructive portfolio flows amid light investor positioning.
More recent posts on the situation in China
Articles on China by Chi Lo
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Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients.
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