Letter from Hong Kong: We outline our view on the coronavirus and how it impacts China’s economic and market outlook.

Nick Chui, Investment Director, Asian Equities, Aberdeen Standard Investments

Wuhan is capital of China’s Hubei province and the epicentre of the current outbreak of novel coronavirus COVID-19. The virus is understood to have originated in a seafood market in the city.

To date most infections and deaths have occurred in Hubei. If you look outside of this eastern Chinese province, the infection rate is nowhere near as high and the mortality rate far lower.

The government has put Hubei under lockdown, severely restricting citizens’ ability to leave. This is unprecedented, underlining the importance authorities have placed on containing the virus not just within China, but globally.

The government has introduced more stringent measures than during SARS in 2003. This will help to bring the situation under control sooner.

The measures it has introduced are more stringent than those implemented during Severe Acute Respiratory Syndrome (SARS) in 2003. This will help to bring the situation under control sooner rather than later.

At the time of writing, Hubei was reporting 2,000 to 3,000 infections daily. It does not have a system to handle this volume of people, which explains why authorities have erected temporary hospitals in record time.

We think the government has acted promptly. Limiting travel and encouraging people to work from home is at least restricting human interactions, in turn limiting transmission of the virus.

Some experts have predicted that the number of infections could peak in March; others expect the virus to dissipate by May as the weather warms up. High season for viruses tends to be winter.

That might suggest this situation will be prolonged for a month or two. During this period we hope to see the number of infections and deaths taper off, together with no new clusters outside of Hubei.

We view the fact that the government stuck to February 10 as the date for Chinese people to return to work outside Hubei as a good sign. It would have pushed this date back if it felt the situation was out of control. When we examine the statistics, we share this more positive view.

Economic impact

Understandably, clients are concerned about the economic and market implications of this latest coronavirus. Hubei is China’s seventh largest province and represents about 4% of China’s GDP. So it is relatively significant.

On the ground we are seeing a slowdown in activity, both economic and social. As a result we expect China’s GDP growth to be negative for the first quarter at least.

Traditionally Chinese New Year is a time when activity levels tend to fall, before picking up again after the break. Because of the virus, we expect a delay in any post New Year pick-up. However, provided this situation is brought under control, we think activity will be restored gradually.

The government does not want to keep social and economic life on hold. It is attempting to tackle the virus, while at the same time striving to minimise disruption to peoples’ daily lives.

But as we look ahead, we would highlight that consumption – particularly online – accounts for a far higher percentage of GDP growth today than it did during SARS in 2003.

Consumption is about people spending, both physically and online. Owing to restrictions on travel and social interaction, we would expect the physical portion to be heavily impacted in the short term.

But online penetration is far higher today than in 2003. What better for people stuck at home than to use their phones to go online and surf the web, using any of China's super apps.

Companies including those we own have kept online channels open. As a consequence we expect the percentage of online sales to be disproportionately higher in this first quarter than in previous years.

The virus is also having a direct impact on areas such as real estate and manufacturing. Temporarily a number of workers have delayed returning to factories. This may lead to a supply shock in certain sectors.

But as we saw during the SARS outbreak, although economic growth in the first quarter was down, by the third quarter activity levels had rebounded. Broadly, we expect something similar this time around.

Embracing volatility

Unsurprisingly as soon as China’s stock markets reopened on Monday, February 3 after the extended Lunar New Year break, they sold off heavily.

But by the following day, some investors were already looking past the coronavirus. Foreign investors in particular chose to enter the market, with Stock Connect recording northbound net inflows.

We expect fear and volatility to persist in the short term. That will likely lead to further bouts of indiscriminate selling, which is when company prices become separated from their intrinsic value.

Historically we have embraced volatility in China’s A-share market. Fear in markets is traditionally a time for investors to seek valuation entry points.

In short, we don’t expect the coronavirus to derail the engine of China’s economic growth. As a result, we expect its impact on China’s markets to be short-lived.

We have analysed each of our holdings to check their exposure to Hubei and consumption in general, and have adjusted accordingly. We will continue to monitor the situation very closely.

But if you believe in China’s long-term structural growth as we do, then a volatile market will present investors with opportunities. We expect these to keep us busy as this situation evolves over the coming months.

Notwithstanding this novel coronavirus, we are in a period where consumption is – and will continue to be –a major driver of China’s economy. We aim to look through short-term disruption to identify areas and companies where we see sustainable growth over the medium and long term. 

Some companies in these sectors – particularly travel – will suffer in the short term. In insurance, agents may not be able to see their clients now because people are staying at home.

But it does not necessarily follow that they will stop buying insurance because of this flu. In fact, it's possible they will buy more, because people tend to feel particularly mortal during times like these.

 

IMPORTANT INFORMATION

Foreign securities are more volatile, harder to price and less liquid than U.S. securities. They are subject to different accounting and regulatory standards, and political and economic risks. These risks are enhanced in emerging markets countries.

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RISK WARNING

The value of investments, and the income from them, can go down as well as up and you may get back less than the amount invested.