The asset manager for a changing world

Senior investment strategist Daniel Morris discusses the potential for further outperformance from Chinese stocks in 2020 with Caroline Yu Maurer, Head of Greater China Equities, and Chi Lo, Senior Economist for Greater China, both from our Hong Kong office. 

 

What can you tell us about the economic impact of the quarantine measures in Q1?

Chi: In the first quarter of 2020 China’s GDP growth contracted by 6.8% on a year-on-year basis. This has thwarted the government’s goal of doubling real GDP in 2020 relative to the 2010 level. If Beijing still wants to achieve that goal, there will be tremendous pressure to implement aggressive monetary easing. There are signs this is underway.

China’s economic growth currently faces two major risks: a potential second wave of COVID-19 cases as the lockdown restrictions are lifted and a collapse in global demand due to the pandemic. Full-year 2020 growth is likely to range between 3% and 4%, but with risk to the downside, depending on the pandemic’s development.

For Europe and the US, if China’s experience in managing the health crisis is any guide, it takes at least 2 months from the start of the outbreak to flatten the pandemic’s growth curve.

The risk is that the US and Europe may need longer than China because it is unlikely that they and other countries would envisage employing the draconian lockdown measures implemented in China. All this underscores expectations for a sharp global growth slowdown in the coming months.

 

How far along are we now in returning to “normal” in China? Is there still any hope for a V-shaped recovery?

Chi: For China, we have seen the industrial sector get back to normal with almost 100% capacity utilisation. It has resumed at a faster pace than the service and consumer sectors where loss of employment and income means they are running below capacity at between 60-70% of their normal activity.

In the rest of the world, normalisation has yet to begin. In my view the pandemic has not yet peaked. There will still be a V-shaped rebound in growth in China, but given feeble aggregate demand the momentum of the rebound will not push China’s growth much beyond 3% year-on-year in 2020. A faster pace of growth would require Beijing to implement a significant package of monetary easing. I do not think China’s economy can get back to the pre-crisis level of growth in 2020.

 

How are you approaching Chinese equities in an even more uncertain world?

Caroline: Due to the unprecedented natural of the current virus outbreak event globally, we do remain cautious during these challenging times and monitor the situation very closely. There is considerable uncertainty about the impact on corporate earnings in 2020. This means local expertise is even more important in providing focus on the market and explore opportunities amid heightened volatility.

To get on top of this unique situation, we focus on three key elements:

These factors drive our level of conviction on stocks. At the moment balance sheet strength is a particular focus as we need to be sure that the businesses in which we invest are not vulnerable to liquidity issues caused by plunging revenues following localised lockdowns.

 

Where do you see opportunities in Chinese equities?

Caroline: Despite being the epi-centre of the crisis, Chinese companies are already recovering well. Central banks globally responded to limit downside risks with monetary easing and governments cross the world undertook fiscal expansion to support the real economy. So far, Chinese equity markets are proving relatively resilient to the effects of the turmoil caused by the coronavirus turmoil.

As regards our current portfolio positioning, our focus is on sectors and companies that are:

  1. Well-run industry leaders (e.g. companies in consumer space, technology).
  2. Sectors that are more resilient to the macro-economic uncertainty (e.g. healthcare).
  3. Companies that are subject to favourable counter-cyclical measures from local governments (g. cement, domestic goods and services).

In contrast we have maintained underweights in sectors most affected most by the outbreak (e.g. energy, industrials) but we will look to buy industry leaders in those sub-sectors where valuations offer attractive entry levels.

We think that China is in pole position for a forthcoming structural transformation. COVID-19 has revealed a number of behavioural changes in China, e.g. increasing penetration of online grocery shopping, online entertainment and online education, higher demand for healthcare devices among both hospitals and households. We are also likely to see an acceleration in industry consolidation.This should play favourably for industry leaders over the longer term.

In terms of our long-term portfolio strategy, over the last few years we have been focusing on three key structural themes where we see potential for outperformance:

  1. Technology/innovation.
  2. Consumption upgrading.
  3. Industry consolidation.

In my view, Chinese stocks offer investors opportunities both in terms of investing and in better understanding the impact of the coronavirus on business.

Chinese society is learning to live with the virus and our economy is recovering. We are optimistic about the rest of 2020. The first quarter was tough but on a relative basis Chinese stocks did well and have considerable potential both for the rest of 2020 and beyond.