Webinar 4 China: out of lockdown and into economic recovery?

China was the first to experience Covid-19, but it is the first to emerge from lockdown. What does the future hold for China's economy, is there a recovery, and what themes should investors watch out for?

20 Apr 2020

China into recovery?

China was the first to experience Covid-19, but it is the first to emerge from lockdown. What does the future hold for China's economy, is there a recovery, and what themes should investors watch out for?

Bin Shi, Barry Gill and Hayden Briscoe discuss in a recent webinar.

Key highlights: China out of a lockdown and into recovery?

  • China's economy is recovering from Covid-19, but has yet to return to normal;
  • Indicators like traffic congestion and coal consumption have shown a meaningful improvement, but we are not yet at the full recovery stage;
  • Covid-19 has revealed a number of behavioural changes in China, such as the shift from offline to online, which present investment opportunities in sectors like after-school tutoring, financial services and healthcare;
  • Leading companies will benefit from ongoing consolidation in many industries as small firms struggle;
  • As world bond markets shifts to negative yields, China government bonds offer a unique value proposition to investors based on low correlation & volatility as well as attractive yields;
  • Despite concerns about data quality, we remain confident in the data being released by the Chinese government.

Can China lead us out of the COVID-19 crisis?

Barry Gill, Head of Investments

On February 6th this year I participated in a podcast in which the host wanted to discuss the market's reaction to the unfolding coronavirus outbreak in China.

The Chinese A-share market had been formally closed over the end of January due to Chinese New Year, but the unfolding drama, including the quarantining of Hubei province, manifested in a 10% sell-off when it opened on February 3rd. By the time of my podcast it had recovered by 80% and then went on to hit a 12-month high in early March.

I framed my responses to the podcast questions in the context of the market focusing on the second derivative - forward looking indicators would trump real time poor economic data.

Ten weeks later I am struck by the simplicity and naïveté of my line of reasoning, particularly given the former option-trader in me fully understands the value of focusing on tail risks.

Covid-19, China and the world economy

I had not factored in the contagion dynamics of the virus, nor the fact that Chinese share of global GDP had quadrupled since the SARS outbreak in 2003.

Furthermore, I had not fully considered that in many senses we had been riding our luck when it came to pandemics and that Covid-19 exposed the lack of preparedness for this type of tail event in the western healthcare system. 

This illustrates how hard it is to forecast the market's moves in the short term. Remember, equity markets hit new highs equity markets hit new highs later in February, although the bond market once again seems to have sniffed out a problem before the equity market.

In the same interview, though, I reiterated the bullish secular views we have held on Chinese equities and bonds at UBS.

We have witnessed lengthy quarantines around the world, which may structurally change how we work, play, learn and travel. We have also witnessed monetary and fiscal responses equal to or greater than what were experienced in the Great Recession after the 2008-2009 Global Financial Crisis.

China is different, but why?

The global mantra is one of acting quickly and forcefully, to avoid any rot taking hold. That is, everywhere except China. Policy responses in China stand out for how muted they have been, in contrast to the $4tn wall of money they spent from 2009-2011. Why is this?

'When the US sneezes the rest of the world catches a cold'. But look at what has happened: from the start of the year, China A-shares are down a modest 5%, troughing down 14%, while the S&P500 is down 12% having bottomed down 31%.

Similarly, US 10 year Treasury yields have plummeted 120bps to generational lows, while Chinese government bonds of a similar maturity have lost half that amount and now yield 180bps more than US Treasuries.

What is happening? How much of what is happening is a temporary aberration and how much is structural in nature? What are the big opportunities that investors are too hesitant to take advantage of? China led us into this current crisis - can it lead us out?

Bin Shi and Hayden Briscoe will each now seek to answer some of these questions.


Behavioural changes and new innovations to drive opportunities in China equities

Bin Shi, Head of China equities

Covid-19 is a global issue, but if you observe some of the trends between countries the trajectory is similar.

Countries that took early action have been more successful at reducing the growth rate of new cases than those that delayed.

That's particularly true in China where the spread of Covid-19 virus has been brought under control.

Looking at activity indicators, we are seeing signs of incremental improvement, but we should take these indicators with a grain of salt

Why has China been so successful with the COVID-19 outbreak?

Two factors are important.

Firstly, the Chinese government took drastic measures. People were locked down in their homes and they closely abided by government rules.

Secondly, the government has used new technology to help monitor population movements. Tencent - one of China's largest tech companies – developed health status QR codes that advised users on what to do and helped separate high risk people from low risk people by using big data to track whether users had been close to the site of an outbreak, or infected people.

Chinese tech companies are using big data and QR codes to help curb the spread of COVID-19

Source: UBS Asset Management, April 2020

Congestion Data in Chinese Cities Show a Return to 2019 Levels

Note: the degree of congestion in 46 large cities and subway passenger traffic in 8 major cities since Lunar New Year Source: AlphaWise, Morgan Stanley Research, as of 12 April 2020

But more traffic doesn't necessarily mean a 'return to normal'

Looking at activity indicators like traffic and coal consumption levels we are seeing signs of incremental improvement.

Take congestion for example, data show that levels have approached those in 2019.

However, we should take that with a grain of salt as few people are taking public transport to avoid travelling in groups, so urban roads are full of cars.

More broadly, inter-city car travel is still low, so it is not true to say that traffic indicators - which many say is a proxy for the economy - have returned to normal 100%.

Focus on behavioral changes and new innovations in China equities

What is important when making an equity investment strategy for China is to gauge the many behavioral changes brought about, and even accelerated by the Covid-19 outbreak.

One of which is the shift from offline to online business in China. Online education is one sector to benefit from a shift. Top online education companies have seen a huge increase in downloads during the Covid-19 outbreak and we feel that the best companies in these spaces have the potential to grow market share from other online competitors.

Online games are another sector that has benefited from increased players during the outbreak period.

MoM (%) increase in Daily Active Users in February 2020

Source: Questmobile as of end Feb-2020

Premiumization thesis still holds in China equities

While retail numbers will have taken a hit in Q1, we feel that the premiumization thesis, i.e. strong demand for high-end, high-quality goods, remains intact.

One way to gauge this is to look at wholesale baijiu prices. If demand was weakening, wholesale prices would fall, but prices have remained firm during the past couple of months. This is of course one indicator, but we haven't seen any convincing evidence yet to suggest that either demand or the willingness to pay premium prices for high-end goods has suffered as a result of the Covid-19 crisis.

Q&A:

Bin Shi (BS): Three main reasons. Firstly, valuations on China equity markets were cheap to start with compared with say US and European equities. Secondly, leverage levels in China are comparatively lower, so there has been relatively less forced selling. Finally, blue chip stocks - which account for a large share of China's markets - have been relatively resilient.

BS: We want to invest as much as we possibly can, but we have to invest with discipline and according to our own criteria on what makes a good investment or not. Recently, it is true to say that we feel that risks have not been properly discounted in many of the names in the opportunity set, so we have held a little more cash than usual.

That said, in many ways we have been as aggressive as possible in terms of our investments, given the current market environment. We have invested in companies that have the potential to benefit from the behavioral changes we have seen during the Covid-19 outbreak, particularly in sectors like e-commerce, online education, big data and cloud computing. Additionally, we have put money to work in companies where we feel risks have been properly discounted. Finally, we have added to our positions in industry leaders in sectors we favour, particularly those that have strong balance sheets and who may benefit from industry consolidation.

BS: We had no position in the coffee company that recently caught the headlines, we looked at it in the past but it didn't meet our criteria.

As for the education company, that is a very different situation. We have been closely following it for nearly a decade and have done intensive channel checks on the company.

We believe that we have a good understanding of the company's corporate culture and credibility of the management and we see the news announcement as a small black spot on what is an otherwise healthy company.

BS: There's no doubt that the outbreak was mismanaged at the beginning and that the true number of cases weren't fully reflected in the data, largely because it took a long time for testing practices to ramp up.

Over time, China's testing and tracking procedures have improved and we are not worried about the credibility of data being published. Furthermore, given the high sensitivity of the government, it is unlikely they would ease lockdown measures if they are not confident that the situation has been brought under control.

Talking to my friends in China, they are now out and about playing golf, going to restaurants etc, and that's just a sign of how things have changed on the ground in China.

BS: We remain positive on the healthcare sector. In part, that's because of fundamentals, like China's aging population and rising spending on healthcare treatment.

The top players in the sector are rapidly developing their R&D capabilities and we see that as a good indicator of their capacity to grow in the future.

In many ways, we see commonalities between the China healthcare sector now and China's IT sector ten years ago. IT was a small part of the market then, but it grew significantly with the rise of key companies like Tencent and Alibaba. We see a similar situation in healthcare and maybe we will see the emergence of a BAT[1] group of companies, like we did in the IT sector.

BS: We have built a wide range of contacts in China over the course of our research in the past twenty years and we are in constant touch with them to understand the situation when we are not travelling as much. Additionally, as more activities move from offline to online we are finding more sources of online information which help us gauge trends effectively.

Time to pick China bonds

Hayden Briscoe, Head of Fixed Income, Asia Pacific

I'll speak from a structural point of view about how Covid-19 is affecting both markets and the asset management industry, and what this means for investors.

The Chinese bond market has a place in everybody's portfolio today. Investors look for diversification and low volatility and Chinese bonds score well on these two measures.

Time to pick the countries

In the past, asset allocators would build bond portfolios by following indexes but now, because of the breakdown in the stock/bond correlation and the shift to zero or negative yields, they will have to spend a lot more time picking the countries for their portfolio.

In this context, the Chinese bond market has a place in everybody's portfolio today. Investors look for diversification and low volatility and Chinese bonds score well on these two measures.

Over the years, Western bond markets have become much more correlated with each other, but that's not really the case with China.

And it’s a similar picture when it comes to market volatility, which have stayed comparatively stable as volatility on world markets has ticked up.

China is a top performer, with attractive yields

These factors are bolstering the case for Chinese government bonds as a safe haven. And if we look at performance over the past year, China has outperformed in terms of total return.

Additionally, yields of between 2% to 3% currently look highly attractive compared to the zero to negative yields available in most developed markets around the world.

Source: Bloomberg, as of end March 2020

No time to wait

Most people around the world have a zero to low allocation to Chinese bonds. If investors are waiting for global indexes to factor China bonds at the weight that reflects China's significance in the global economy, they will have a long time to wait.

That's why moving away from indices and picking the right countries will become increasingly important and we believe China has to be part of investors' global portfolios. And the case is strong: it offers diversification, low volatility, yield and low credit risk in the government space since China remains a net creditor nation.

Additionally, if we do see a global recession, China is one of the best spaces to be invested in because it is a market that can rally by say 200bps, and there is limited scope to do that in many other developed markets.

Nominal yields on 10-year sovereign bonds

Source: Bloomberg, as of end March 2020

What is China's 2020/2021 economic outlook?

China's economy will grow an estimated 1.2% y-o-y in 2020 and 9.2% y-o-y in 2021, according to the most recent estimates by the International Monetary Fund (IMF). Global economic growth will drop by 3.0% y-o-y in 2020, and grow 5.8% y-o-y in 2021, according to IMF estimates released on April 14, 2020.

Q&A:

Hayden Briscoe (HB): There are differences in terms of size, but what's different in China is the set-up. China's banking system has a long history of directly lending into sectors and getting money into the economy quickly.

Policy banks in China - China Development Bank, Export-Import Bank of China and Agricultural Development Bank of China – have been directly lending to support strategic initiatives, like Belt & Road, as well as stepping up to the plate during times of crisis and getting money into the economy quickly.

That's a key difference to say the US and Europe, where they don't have the same kind of plumbing to directly inject capital into the economy.

HB: None at all. This is a long-term, multi-decade plan and we see no sign of China letting up on its policy direction.

Additionally, it will become even more important for China to open its capital markets in the coming years, that's because China is moving from being a current account surplus nation to one that runs a deficit, so the ability to attract international capital will be vital.

HB: With the opening of channels like Bond Connect and the China Interbank Market Direct, we are able to trade in and out of China's onshore bond markets as much we want.

As for duration, five years is about right for portfolio construction with Chinese bonds. In the West, the duration for all indexes is moving out to between seven to eight years.

Subscribe now

Perspectives matter. Tune in to our insights.

More insights

Singapore Retail Investors

PLEASE READ THESE TERMS AND CONDITIONS CAREFULLY BEFORE PROCEEDING. BY UTILIZING THE WEBSITE AND PAGES THEREOF LOCATED AT WWW.UBS.COM/AM-SG ("WEBSITE"), YOU ACKNOWLEDGE THAT YOU HAVE READ THESE TERMS AS WELL AS THE GLOBAL TERMS OF USE (collectively "TERMS") AND THAT YOU AGREE TO BE BOUND BY THEM. IF YOU DO NOT AGREE TO ALL OF THE TERMS OF THIS AGREEMENT, YOU ARE NOT AN AUTHORIZED USER OF THESE SERVICES AND YOU SHOULD NOT USE THIS WEBSITE.

This website is not intended for and should not be accessed by persons located or resident in any jurisdiction where (by reason of that person's nationality, domicile, residence or otherwise) the publication or availability of this website is prohibited or contrary to local law or regulation or would subject any UBS entity to any registration or licensing requirements in such jurisdictions. It is your responsibility to be aware of, to obtain all relevant regulatory approvals, licenses, verifications and/or registrations under, and to observe all applicable laws and regulations of any relevant jurisdiction in connection with your entrance to this website. Each investment product and service referred to on this website is intended to be made available only to residents in Singapore.

UBS reserves the right to change, modify, add or remove content on the website as well as these terms at any time for any reason without notice. Such changes shall be effective immediately upon posting. You acknowledge that by accessing our website after we have posted changes to these terms, you are agreeing to these terms as modified.

The materials on this Website are distributed by UBS Asset Management (Singapore) Ltd (company registration number: 199308367C), which is licensed by Monetary Authority of Singapore ("MAS") in Singapore pursuant to the Securities and Futures Act (Chapter 289 of Singapore). UBS Asset Management (Singapore) Ltd is part of the Asset Management business division of UBS Group AG. UBS Asset Management (Singapore) Ltd together with UBS Group AG and its group companies shall collectively be referred to as "UBS".

The information contained in this Website has been prepared and is intended for general circulation. The information does not constitute advice and does not take into account the specific investment objectives, financial situation, or particular needs of any particular person. The investment services or products referred to in this Website may not be suitable for all investors. UBS recommends that you independently evaluate particular investments and strategies and seek independent advice from a financial adviser regarding the suitability of such investment products, taking into account your specific investment objectives, financial situation and particular needs, before making a commitment to purchase any investment products. Investment involves risks. You should be aware that investments may increase or decrease in value and that past performance is not indicative of future performance.

The information contained in this Website is not an offer to buy or sell or the solicitation of an offer to buy or sell any investment product or to participate in any particular trading strategy. UBS, its officers and/or employees may have interests in any of the investment products referred to on this Website by acting in various roles. UBS, its officers and/or employees may receive fees, commissions or other benefits for acting in those capacities. In addition, UBS, its officers and/or employees may buy or sell investment products as principal or agent and may effect transactions which are not consistent with the information set out in this Website.

You fully understand and agree that, by making available this Website, UBS should not be construed as making: (a) any endorsement of any investment product referred to in this Website; (b) any representation that UBS has performed any due diligence on any investment product referred to in this Website; or (c) any representation that the information in this Website is complete, accurate, clear, fair and not misleading. The use or reliance on any such information contained in this Website is at your own risk and any losses which may be suffered as a result of you entering into any investment are for your account and UBS shall not be liable for any losses arising from or incurred by you in connection therewith. UBS is not responsible or liable for the accuracy and completeness of any such information or the performance or outcome of any investment made by you after receipt of such information, irrespective of whether such information was provided at your request.

Using, copying, redistributing or republishing any part of this Website without prior written permission from UBS is prohibited. Any statements made regarding investment performance objectives, risk and/or return targets shall not constitute a representation or warranty that such objectives or expectations will be achieved or risks are fully disclosed. The information and opinions contained in this Website is based upon information obtained from sources believed to be reliable and in good faith but no responsibility is accepted for any misrepresentation, errors or omissions. All such information and opinions are subject to change without notice. A number of comments in this Website are based on current expectations and are considered “forward-looking statements”. Actual future results may prove to be different from expectations and any unforeseen risk or event may arise in the future. The opinions expressed are a reflection of UBS’s judgment at the time this document is compiled and any obligation to update or alter forward-looking statements as a result of new information, future events, or otherwise is disclaimed.

UBS does not hold out any of its officers and/or employees as having any authority to advise you, and UBS does not purport to advise you on any investment product. Any investment will be made at your sole risk and UBS is not and shall not, in any manner, be liable or responsible for the consequences of any investment.

This Website and its contents are provided on an “as is” and “as available” basis. UBS does not warrant: (a) the accuracy, timeliness, adequacy commercial value or completeness of this Website or its contents, and expressly disclaims any liability for errors, delays or omissions in the contents, or for any action taken in reliance on the contents; (b) that your use of and/or access to this Website or its contents, will be uninterrupted, timely, secure or free from errors or that any identified defect will be corrected; (c) that this Website or any content will meet your requirements or are free from any virus or other malicious, destructive or corrupting code, agent, program or macros; (d) that any information, instructions or communications posted or transmitted by you through this Website is secure and cannot be accessed by unauthorised third parties; and (e) that use of the contents in this Website by you will not infringe the rights of any third parties. No warranty of any kind, implied, express or statutory, including but not limited to the warranties of non-infringement of third party rights, title, merchantability, satisfactory quality or fitness for a particular purpose and freedom from computer virus or other malicious, destructive or corrupting code, agent, program or macros, is given in conjunction with this Website.

You hereby agree to indemnify UBS and any of its officers, employees or agents against, and to keep UBS and any of its officers, employees or agents harmless from, any claims (actual and threatened), settlement sums, liability, loss, damages, costs (including solicitor and client costs and expenses (legal or otherwise)), charges, expenses, actions, proceedings, whether foreseeable or not which we may sustain, suffer or incur, directly or indirectly out of or in the course of or in connection with any the following: (a) any use of this Website or the contents by you, or any part thereof; (b) UBS having made available the Website; (c) any breach of these Terms by you, however arising; or (d) any negligence, act or omission, wilful default, unlawful act, fraud and/or misconduct on your part or violation of any rights of another person or entity by you.

The funds referred to in this Website have been authorised or recognised by the MAS for sale to the public in Singapore (the “Funds”). Copies of the registered Singapore prospectuses ("Prospectuses") referred to in this Website have been lodged with and registered by the MAS. The MAS assumes no responsibility for the contents of the Prospectuses. The registration of the Prospectuses by the MAS does not imply that the SFA or any other legal or regulatory requirements have been complied with.

MAS registration is not a recommendation or endorsement of a Fund nor does it guarantee the commercial merits or performance of such Fund. It does not mean that a Fund is suitable for all investors nor is it an endorsement of its suitability for any particular investor or class of investors. UBS Asset Management (Singapore) Ltd has been appointed as the representative for the Funds in Singapore for the purposes of performing administrative and other related functions relating to the offer of Shares under Section 287 of the Securities and Futures Act, Chapter 289 of Singapore (the "SFA") and such other functions as the MAS may prescribe.

You may not assign your rights under the Terms without our prior written consent. UBS Asset Management (Singapore) Ltd may assign our rights under the Terms to any third party.

No person or entity who is not a party to the Terms shall have any right under the Contracts (Rights of Third Parties) Act, Chapter 53B of Singapore or other similar laws to enforce any term of the Terms regardless of whether such person or entity has been identified by name, as a member of a class or as answering a particular description. For the avoidance of doubt, this shall not affect the rights of any permitted assignee or transferee of the Terms.

These Terms shall be governed by, and shall be construed in accordance with, the laws of Singapore. The courts of Singapore shall have exclusive jurisdiction to hear and determine any suit, action or proceeding, and to settle any disputes, which may arise out of or in connection with these Terms and, for such purposes, you agree to submit  to the jurisdiction of the courts of Singapore. Each party hereby waives any objection which it might at any time have to the courts of Singapore being nominated as the forum to hear and determine any proceedings and to settle any disputes and agrees not to claim that the courts of Singapore are not a convenient or appropriate forum.

© UBS 2020 - the key symbol and UBS are among the registered and unregistered trademarks of UBS. All rights reserved.

Reset