Chinese stock markets had experienced a stellar 2019 with mainland A-shares up by over 35% in US Dollars but this halted abruptly in January as the outbreak of COVID-19 over the Chinese new year made world headlines.
The virus is of course first and foremost a human shock. For readers who are personally affected we hope for a swift recovery.
Financial markets have somewhat mirrored the fortunes of infections. Chinese equities had started the year strongly as investor sentiment improved following an initial U.S. trade deal and more encouraging economic data. However, markets fell as much as 10% as news of the virus outbreak created shock and panic among investors. The rollercoaster ride continued with a strong recovery in February thanks to Chinese government stimulus. Now it is clear the pattern has spread to global markets.
Considering the effects of the virus in more detail, the impact on factories and service businesses has been well documented in the press. The asset management industry has seen some physical dislocation (staff staying home and not travelling) but by our observation limited disruption to ongoing operations. China-focused investment managers we talk to are watching markets closely and looking out for oversold opportunities.
In anticipation of the market correction, the People’s Bank of China pledged an injection of RMB1.2 trillion (USD174 billion) to the financial system, in addition to cutting borrowing rates by 10 bps. (The Federal Reserve made a more aggressive rate cut, which ended up frightening markets as much as supporting them.) Investment managers we speak to believe that the Chinese measures help cushion near-term pressures and expect policymakers to take further steps to ensure markets continue to function properly.
The SARS outbreak in 2002/3 is the closest parallel we have to evaluate possible implications of this outbreak. Chinese equities declined during the initial SARS period, with the Hang Seng Index losing 18% in early 2003. Once the outbreak was contained, markets rebounded by around 50%, leaving a +35% return for 2003 overall.
While the new virus appears to be less deadly than SARS, it is more contagious and far more widespread across the country and now growing quickly outside of China. Despite forceful control of spreading the disease by the Chinese government and others, it might take a similar time (4-6 months) or even longer to contain the virus compared to SARS. As a result it will have a greater economic impact due to widespread closures, travel restrictions and cancellations. Drawing from the SARS experience, the COVID-19 outbreak could detract China’s annual GDP growth by 2% or more, without meaningful policy support.
As infections and fear spread globally, the most important development for patients and market sentiment will be news of an effective therapy. Numerous drugs are currently in clinical trials in China and elsewhere and vaccines are also in development but will take longer to validate. The current negative news cycle may therefore persist in the short run.
In the short-term, there is no doubt that there will be a negative impact on the Chinese economy due to slowing business activities and reduced consumer spending. One Chinese investment bank estimates the impact on non-financial mainland companies’ earnings to be a reduction of 20-30% in Q1 2020 and a reduction of 5% overall for 2020. Principal ‘losers’ will be service industries like restaurants, airlines or entertainment venues. On the other hand, e-commerce and online gaming are significant net beneficiaries of any lockdown. E-commerce accounts for 20% of China’s total retail sales. According to China's state-backed gaming data company CNG, revenue of the mobile gaming sector during the New Year holiday in 2020 was 33% higher than last year, and generated RMB4.8bn (USD686 million).
The impact is not just restricted to China. At the time of writing, non-Chinese companies across the world ranging from JCB in the UK to Tesla in the US are reporting obstructions in their supply chains. The CEO of Jaguar Land Rover recently said they had flown parts to the UK in suitcases! However, as and when shutdowns become more prevalent worldwide, there will be a significant short-term impact on consumption, and there will be business casualties – the recent failure of FlyBe was blamed on demand reduction due to virus fears.
In the long-term, the economic and business impact should be muted both in China and the rest of the world. Some experts believe that, in a worst-case scenario, the new virus may become another common respiratory disease like seasonal influenza and be managed “ordinarily”.
At RisCura, we believe that the short-term volatility in the market can create excellent buying opportunity for long-term investors. Just like the Chinese term for “crisis” (危机) is composed of two characters signifying “danger” and “opportunity” respectively, valuations of some high-quality stocks are becoming compelling.
Lars Hagenbuch, Consultant, at RisCura
