China Struggles to Get Back to Work
Timothy Fung, Head of Equity Advisory, Asia & Tony Lau, Senior Investment Advisor, Asia
Investor Sentiment Remains Cautious in the Near Term
Global equity markets retreated sharply in response to the sharp rise of new confirmed COVID-19 cases globally, especially in South Korea, Italy and Iran (Diagram 1). On 23 February 2020, the G20 financial chiefs and central banks warned of potential downside risks of the global economy persisting.
It is obvious that the latest development of COVID-19, which was largely ignored by western investors in January, has become the top concern of global equity investors and will continue to dominate investor sentiment in the near term.
Locally, Hong Kong budget 2020/21 rolled out an unprecedented stimulus on 26 February, following Singapore's budget stimulus to counter virus impact. With cautious sentiment and rising unemployment, Hong Kong secondary home prices started to see double-digit percentage cut in offer prices, following weeks of transactions numbness, and several high-end luxury units reported cutting up to 28% of asking price and sold at lost.
DIAGRAM 1: MSCI WORLD VS CORONAVIRUS CASES INDEX
Source: Bloomberg, as of 24 February 2020. The above chart is for reference only and does not represent current or future performance.
Before end-of-March: The Resumption of NPC Meetings?
We believe the State Council is working hard to facilitate the containment progress and most investors believe that, once the State Council announces the new date of the National People’s Congress (NPC) meetings (originally planned to convene on 5 March 2020), it could be an indication that the virus outbreak is under control.
Consensus base case assumption is that the virus full containment will happen before end of 1Q20. The negative impact on economic growth should taper into 2Q20.
In fact, China’s economy has been running at just 40% to 50% of capacity in between 10 and 14 February (Diagram 2 & 3), with large variations across sectors. Based on a containment assumption (with a severe but short-lived impact), the market is expecting the virus to take China’s 1Q20 GDP growth down to 4.5% year-on-year (YoY), compared with 6% in 2019.
DIAGRAM 2: TRADING VOLUME OF RMB VS USD
Source: Bloomberg, as of 24 February 2020
DIAGRAM 3: OPERATING RATES IN COPPER TUBEMANUFACTURERS, BY SIZE
Source: Bloomberg, Shanghai Metal Market, as of 26 February 2020
Policy Focus Shifting From Quarantine to Production Resumption
Chinese government at all levels continues to launch stimulus (Diagram 4). Apart from the Central Bank lowering the loan prime rate (LPR) and opening the market operations (OMO) injections, regional governments such as the Yunnan government, has announced an infrastructure plan of up to RMB3.6 trillion, including over RMB100 billion investments in high speed rail from Kunming to Lijiang as part of its original plan for over 20% YoY growth in infrastructure investment and building more roads for rural cities.
Furthermore, the key objectives of the Central Politburo committee meeting on 21 February were to bring COVID-19 under control and offset the ensuing economic slowdown.
The meeting ended with a consensus to focus on promoting consumption and investments. The Central government also wants to accelerate investment in selected industries such as pharmaceutical, vaccine, biotech, medical equipment, 5G and industrial Internet.
DIAGRAM 4: CHINA POLICY TIMELINE
Source: Bloomberg Economics, as of 25 February 2020 . The above chart is for reference only and does not represent current or future performance.
Specifically, with regard to 5G commercial trial progress, the Ministry of Industry and Information Technology (MIIT) held a meeting on 22 February 2020, focusing on accelerating
1) 5G development, and
2) Resumption of production/operation of the information and communication technology (ICT) industry.
If we conservatively assume the current market expectation is 700,000 5G base tower station (BTS) to be built in 2020, and the government were to push this target to 1 million, this would imply an additional RMB60 billion in capital expenditure (CAPEX).
Market expectations for 5G phone shipments in 2020 remain at 200 million units (Diagram 5), which in our opinion has not yet reflected the risks from virus outbreak - not only China but also the supply-side disruptions in South Korea.
Having said that, we agree with the market on its optimism on 2H20’s sharper-than-normal rebound, along with typically slower device sales early in the year. In general, most investors believe China handset vendors’ potential delay in product launches could flood the market and lead to fiercer competition later this year, when Apple debuts its 5G iPhones.
DIAGRAM 5: 5G PHONE SHIPMENT ESTIMATES FOR 2020
Source: IDC, Gartner, Counterpoint Research, as of 25 February 2020. The above charts is for reference only and does not represent current or future performance.
The New Era of Connectivity of People
With less than three months, the COVID-19 outbreak has triggered the evolvement and adaptation of new innovations and new business ideas.
In a number of areas, the replacement of offline by online has further accelerated. For example, working from home/ other locations is likely to become popular even after the pandemic is over, which should call for a structural demand growth for remote working and clouding infrastructure/software.
Similarly, online education is increasingly replacing classroom teaching, and this trend will continue as students and teachers recognise the convenience and flexibility offered online.
Healthcare reform is likely to be implemented through more technology applications including remote diagnostic, remote treatments, big data etc. that will require more involvement of the private sector, besides the traditional public sector.
With the enabling technologies of internet of things (IoT), and artificial intelligence (AI), the current virus outbreak is adding incentives for entrepreneurship and innovation to flourish into a megatrend, as structural themes always follow where the capex goes.
"We continue to increase weighting in the new economy sectors while steering away from the old economy. We also believe that dividend growers will continue to shine."
"Cash flow and dividend of these fast-growing new economy companies are expected to grow over time, as their business models become more mature. Over the long run, indexes with these new economy dividend growers as underlying should outperform the overall market."