Shreemati Varadarajan is Head of investments at AAM Advisory, part of Quilter.
Almost two months on from the outbreak of the coronavirus in Wuhan, the world’s attention remains firmly fixed on the devastating human and economic consequences of the virus and the impact it may have on global markets. Economic commentators have speculated widely on the potential impact, with some predicting only a temporary dip in equity markets and others forecasting a ‘black swan’ event that may strangle markets and the global economy throughout 2020. As such, there is a distinct undersupply of certainty for investors attempting to grapple with their investment choices and considering increasing their exposure to Chinese equities.
What we do know for certain is that the immediate economic impact is inherently unknown, and the fear of the unknown has been gripping equity markets across the world, but particularly so in China. When markets opened after the extended lunar New Year holiday, the CSI 300 index fell 9.1%, and in doing so experienced its worst opening in nearly 13 years. Although markets have since rebounded to regain some of the losses, they are still struggling to assess the extent of the economic damage caused by the contraction in demand and disruption to global supply chains. This uncertainty is set to continue as the effects of the virus ripple through the global economy, weighing further on equity prices, particularly in sectors most exposed such as luxury goods, aviation and energy. The Chief Executive of Alibaba, which sells two-thirds of everything bought online in China, has said that the virus will bring the country to a “standstill” in the coming months.
For an investor with a long-term horizon wanting to take advantage of the volatility, this may be the ideal time to seek out buying opportunities and increase exposure to Chinese equities as prices are weighed down by the short-term uncertainty.
Manias, panics, crashes and epidemics are an all too frequent feature of financial markets, but follow a similar pattern of short-term disruption followed by long-term recovery, and there is little evidence that this time will be any different. There have been 9 major disease outbreaks since 1998 and although all caused short-term economic disruption, the impact on long-term investment fundamentals was limited and economic growth subsequently resumed1. Of course, the past cannot predict the future, but it should guide investors to focusing on long-term fundamentals when making investment judgements after an epidemic outbreak.
As such, the economic picture in China was largely positive in the latter stages of 2019. On the demand-side, value-added tax cuts and payroll tax reductions drove positive effects on consumer spending, keeping retail sales in high single-digit growth year-over-year into the fourth quarter. On the supply-side, the Caixin China General Manufacturing PMI signaled continued expansion toward a three-year high. In the longer-term, we expect sustainable growth in corporate earnings, particularly among companies that benefit from an increase in domestic sourcing of key value-added components.
There were also promising signs of a de-escalation in trade tensions between the US and China before the out outbreak of the virus, and it is likely that this will continue into 2020. China announced a $75bn reduction in tariffs on imported goods from the US, on top of the recently signed phase 1 trade deal, and Chinese officials have every incentive to de-escalate trade tensions and support their export markets. In the US, there are rumblings that the trade war is damaging exporters in the majority of US states2, including President Trump’s stronghold states of Texas and Alabama. This may prove crucial going into the US election at the end of the year.
In terms of monetary policy, the People’s Bank of China (PBOC) has been quick to react and respond to the crisis in the hope of steering China’s economy back to its long-term growth path. In late January, the PBOC announced it would provide $71bn of banking liquidity through reverse purchase agreements in order to push down interbank lending rates and provide an economic stimulus. Interest rates on medium term lending facilities to financial institutions were also cut on Monday to provide fresh stimulus directly into the economy.
Once the immediate threat to human life is contained, by controlling the spread of the virus or by finding a cure, we expect positive corporate earnings to continue and the structural growth in China’s economy to be sustained. China has achieved an astronomical GDP growth rates in the past 30 years, averaging 6% year-on-year growth, and although the Coronavirus will reduce the level of growth to around 4.5% this year, this is still among one of the fastest growth rates anywhere in the world.
With the uncertainty weighing on equity prices in Chinese markets, investors who are looking to invest over a long-term horizon, and are prepared to take on a little more risk, should consider exploiting the current market volatility and purchase undervalued Chinese equities. China remains one of the fastest growing economies in the world with the largest population, and the long-term growth prospects should continue to entice investors.
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