Keep calm and carry on investing

Frank Tsui, senior fund manager, Value Partners

Frank Tsui, senior fund manager at Value Partners in Hong Kong, explains how the Coronavirus has affected Asian markets and says normal service will resume and that growth is likely to rebound


History, from diseases to economic cycles, often uncannily effects a playback. While health experts believed that the world was statistically overdue for a global viral outbreak, no one predicted that a Coronavirus which first broke out in Wuhan, the capital of Hubei province, China in late 2019, could escalate into infecting over 75,000 globally, with close to 99% of cases confined to the mainland.

Across China, the public and health authorities are on high alert as the respiratory infection, known officially as Covid-19, has claimed more than 2,000 lives on the mainland – conjuring a sense of déjà vu to the experience of 2003 severe acute respiratory syndrome (SARS). With the number of Coronavirus deaths surpassing the SARS epidemic, investors are now assessing its potential impact, given that the latter had clobbered both the economy and markets at large.

China’s economy unmasked

China is the conduit of global supply chains as the workshop of the world and ripples would be greater in magnitude compared to SARS as its economy is much larger now than it was in 2003. The measures to curb the spread of the virus – city lockdowns, quarantines and extensions to the Chinese New Year holiday season means that production schedules in 20 provinces have been affected. The resumption of production in these factories play a role in China’s first-quarter growth as these provinces are estimated to contribute over 70% of China’s gross domestic product (GDP).

The tertiary or services sector in China which grew to a 53% share of the economy (from 41% in 2002), is also expected to take a dive as consumption levels suffer from the curtailed movement of people in the near term.

These services cover a wide range of sectors from tourism services to catering that is an increasingly important role for China as spending power increases. China’s economy grew by 6.1% in 2019, according to the National Bureau of Statistics, and growth will certainly be under pressure in the first quarter as a result of the virus outbreak.

Rearview mirror

Although a short-term impact is unavoidable, a long term material impact is unlikely. In a similar vein, we noticed in 2003 that initially, the magnitude of market declines was inversely related to the new number of SARS cases. Thereafter, both the MSCI China and MSCI Hong Kong emerged from the trough when the number of SARS cases peaked which meant that markets reacted positively upon a rate of a decline in new cases.

To put things into perspective, the MSCI China and MSCI Hong Kong recovered alongside observable control to the epidemic before surging further towards the end of 2003 – total returns were over 100% and 52% respectively from the lows in April 2003 after they tumbled around 13% from their highs in early 2003.

The selling pressures associated with SARS lasted little over three months and abated even before the World Health Organization lifted the travel warning for Hong Kong in May 2003.

Vital signs of recovery

If we use 2003 as a guide, the Coronavirus would be a one-off event with growth levels resuming to normal once the conditions are settled.

Beginning on 4 February 2020, several indexes (the Hang Seng, MSCI China and S&P 500) showed signs of rebound after new infections began to show signs of deceleration.

Additionally, noticeable differences exist between the death rates; Covid-19 has an overall fatality rate of around 2% (as of 20 February 2020), which is significantly lower than the SARS mortality rate of about 10%.

Among the infected, an estimated 14,000 (or nearly 19%) have survived the ordeal, and markets have reacted optimistically upon acceleration to the recovery cases.

Post-mortem notes

Concurrently, many unknowns to the Coronavirus (including its spread and control measures) means uncertainty and market volatility are here to stay in the near term. Since the impact of the virus disproportionally affects the Greater China region, the overall risk premium to China and Hong Kong markets have increased. Against the uncertain market outlook, we expect policymakers to ignite stimulus plans on a larger scale for both monetary and fiscal policy easing. Before the virus outbreak, our portfolios had insignificant exposures to sectors that were vulnerable to lower tourism traffic and consumer spending appetite, namely airlines, transportation, hotels, casinos and luxury brands. These will require some recovery time from the dampened sentiment and face challenges to their earnings forecasts in 2020.

Hong Kong markets are also priced attractively, as fear-based sentiments are driving valuations similar to during the SARS period with the Hang Seng Index trading at 0.6 standard deviation below its ten-year average price to earnings ratio.

Breathing room

In spite of the near-term volatility, we continue to be driven by bottom-up stock selection, favouring companies that exhibit solid growth over the medium to long term. Much of our conviction remains on technology, consumption upgrades, and healthcare.

In the Greater China bond markets, travel and consumer-related sectors will see a benign impact as these sectors have fewer bonds outstanding. The main component to watch is property, keeping in mind that housing demand amongst buyers should be delayed and should resume once the epidemic is contained.

The imminent impact will be on property developers’ sales in the first quarter of this year. We believe it could lead to softer contracted sales guidance in 2020 from the previous growth rate expectation of 10-30%. That said, while January and February are normally slack seasons for property sales, developers are expected to further postpone project launches to cope with the situation.

When it comes to developers with landbanks in the USD bond space, we do not foresee a big shortfall in saleable resources from developers to support a mild growth in contracted sales for the year. This is because most developers have a diversified landbank, and Hubei province (including Wuhan city) typically accounts for a single-digit percentage point of landbanking in gross floor area. On the liquidity side, amid expectation of slower sales in 1Q, developers are likely to remain financially prudent to preserve liquidity. As such, land purchases and new construction project will dip.

According to ratings agency Standard and Poor’s, rated developers issued US$74bn worth of offshore bonds in 2019. Since the beginning of 2020, more than US$17bn (investment grade: US$1.5bn; high yield: US$15.9bn) worth of bonds have been issued, which already covers the majority of refinancing needs for 2020 at a total of US$23bn.

The credit metrics are hence manageable unless the contagion stretches over an unreasonably long duration.

Seasons in the sun

Viruses do not last forever – many tend to peak in the colder winter months and die down in warmer summer weather. Scientists from Hong Kong University showed that low temperatures and low humidity enabled viruses such as SARS to survive longer than they would in high temperatures and high humidity, and the current Coronavirus strain would slow when the weather warms up. The comparisons to SARS in terms of economic fallout and rebound above suggests that the market prognosis from Covid-19 will follow a similar trajectory, that is, growth will rebound and the economy will resume normalcy.