China A-shares: the investment themes as the crisis fades
So far this year, China’s A-share market has been relatively resilient, holding up better through the Covid-19 crisis than other global and regional markets.
Indeed, the MSCI China A Onshore Index is down just -1.8% as at 8 May. This compares to falls of -11.8% for the MSCI World, -8.2% for the MSCI USA, -12.1% for the MSCI South Korea and -9.6% for the MSCI Taiwan (all returns in US dollar terms).
For those unfamiliar with the mainland China markets of Shanghai and Shenzhen, we wrote this primer towards the end of last year.
Why has the A-share market been so resilient so far this year?
Despite being the first country to experience Covid-19 cases, China has been able to contain the outbreak relatively quickly, helped by the swift and effective response from the government, including the aggressive use of quarantines.
With the exception of certain industries such as tourism that are still affected by the virus outbreak, life in many parts of China returned to normal in mid-to-late February, with a lot of companies resuming work. In March, the vast majority of manufacturing plants were back online.
We believe the early and successful containment of the outbreak is one of the reasons why the A-share market has outperformed its peers. We also believe that many investors have been impressed by China’s top-down systems and their effectiveness. The successful demonstration of China’s effective crisis management response appears to have bolstered investors’ confidence in the China A-share market.
How is the economy holding up and is the government providing stimulus?
The virus outbreak will certainly affect the economy and act as a drag economic growth. China reported its first negative quarterly GDP growth reading on record for the first quarter of 2020. And the outlook for Q2 remains extremely challenging.
Although the domestic economy is back on its feet, most developed economies are likely to experience a dramatic contraction in economic growth in the second quarter. As a result, demand for manufactured goods from China is likely to drop off, which will negatively affect China’s export segment. Bear in mind that exports account for around 20% of GDP.
Having said that, we can expect a boost in both fiscal and monetary policy support, as the Chinese government looks to mitigate some of the negative economic impact of Covid-19.
On the monetary front, the key measures so far include the lowering of interest rates and reserve ratio requirements for commercial banks, enabling them to provide greater lending capacity. The People’s Bank of China (PBoC) has cut the targeted required reserve ratio several times, hoping to direct more lending to the small-medium sized enterprises, which provide around 80% of the country’s jobs.
The PBoC has also pledged to take further support measures, as is required to meeting its policy targets.
On the fiscal side, the government has taken measures including the raising of the local government bond quota, which is typically used to fund infrastructure investment). There’s also been a temporary social security tax cut for businesses and an electricity price cut for certain companies. Local governments have also provided subsidy plans and support.
But the government has also committed to doing more. The politburo meeting held in late March sent a strong pro-growth signal, highlighting the need to raise fiscal deficits (i.e. increase spending), issue special government bonds, and further increase the issuance of local government bonds to drive fixed asset investment.
These measures are all very supportive to the sentiment of the A-share market in our view.
What investment themes do you see in China A-shares?
Looking ahead, we believe the key investment theme could be related to fixed asset investment in the country, given the supportive government policies.
Apart from the traditional fixed asset investment such as the construction of new railways and expressways, the government has more recently promoted the concept of “new infrastructure”. This includes 5G, the internet of things and artificial intelligence etc. Therefore, we believe 5G-related industries should be an area of focus.
On the consumer side, we continue to see the rise of domestic brands, becoming industry leaders in various sectors. We still think many of them show strong growth potential.
Last but not least, we believe the government will further increase its spending in the healthcare sector after this crisis, and we will continue to look for opportunities.
What are the main market risks?
We are conscious of increasing political tension between the US and China. Some US politicians have recently called for China to be held accountable for the costs associated with the Covid-19 pandemic. Whether this issue escalates further is yet to be seen, but it nonetheless bears close monitoring.
Meanwhile, a technology-related dispute between the two nations continues, amid speculation that telecoms company Huawei will be subject to harder sanctions. Such a move would also cast uncertainty over the outlook for supply chain-related companies. The US and China signed a phase one trade agreement earlier this year, but whether the two sides adhere to the terms remains to be seen.
In addition, weak demand from overseas, discussed above, may feed into various market sectors. The technology space, particularly related to handsets, is an area we continue to assess. 2020 is set to be the year of proliferation of 5G. Apple is scheduled to launch its 5G iPhone by the end of the year, and any delay would be a concern.
Various supply chains have already been disrupted in different parts of the world, and that led to recent delay in production at Tesla’s Shanghai plant. Whether the supply disruption of critical components could impact certain industries is also another risks we need to consider.
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