China market reactions and government measures
China’s financial markets resumed trading on 3rd February after an extended Chinese New Year break, with the markets initially selling off -9% in Shenzhen and -8.7% in Shanghai during early trading.
Before the markets opened, Chinese regulators, ministries and local governments announced policy measures to contain the downward impact from the coronavirus on the economy. In all, the government announced 30 measures across 5 ministries and regulators to provide economic support.
The People’s Bank of China (PBoC) announced large-scale open market operations by injecting 1.2 trillion-yuan worth of liquidity into the markets via reverse repo operations and lowered the 7-day reverse repo rate to 2.4% from 2.5% and cut the 14-day tenor to 2.55% from 2.65%.
The latest situation
The novel coronavirus outbreak has killed a further 45 people in China and infected 2,590 more, the National Health Commission in Beijing announced over the weekend. The overall death toll has surpassed 360 with over 17,000 confirmed infections.
As the Coronavirus outbreak continues, most Chinese provinces have suspended business activities until 9th February. An increasing number of countries around the world have imposed temporary travel restrictions to/from China following the World Health Organization’s global emergency announcement, however restrictions on goods to/from China are unlikely.
From an economic growth perspective, we expect the coronavirus to have the greatest impact on China and Asia’s GDP in Q1 2020 and a slight improvement in Q2. Compared to SARS in 2003, expectations this time are for a stronger, more negative impact towards the beginning stages, as new cases should peak in Q1.
We think that the number of new infections will moderate starting some time in Q2 as China’s and other government’s remediation responses have been swifter and much more transparent than in 2003.
Accordingly, the coronavirus is expected to have the greatest impact on China’s GDP in Q1. As the number of new infections moderates in Q2, with consumption returning and positive impacts of the Phase 1 deal working their way through positive corporate and consumer sentiment, we think that a rebound in economic activity will occur starting the end of the quarter.
The recent PBOC’s easing monetary policy should positively impact the Chinese economy for the rest of the year and we forecast a strong rebound in the 2H 2020. Beijing will continue to stimulate the economy for the rest of 2020, either through monetary stimulus such as cuts to the RRR (reserve ratio for banks) and MLF (medium-term lending facility) and fiscal stimulus through higher local special bond quotas and temporary tax exemptions.
We emphasize that the coronavirus is a temporary speedbump in the growth of the Chinese economy in 2020 and that Beijing has the monetary and fiscal stimulus tools to counter any significant negative impact that this headwind may bring.
At this point, even though valuations are starting to appear attractive at these levels, we continue to expect market volatility in the near-term on China A shares and H shares as we are in the midst of the escalation period. It makes sense for market participants to wait for signs of stabilization before stepping in to add exposure.
For long-term investors – we think that they should stay the course, not flee equities and continue to be diversified. Markets adjust rapidly and already bargain opportunities are starting to appear in both China A and H shares. The long-term fundamentals of the Chinese economy are still unaffected.
For investors with a shorter-term investment horizon, it makes sense to hold a lower-volatility portfolio, heavier weighted in less risky assets.
Although the RMB will be under pressure in the near-term, I expect the RMB to outperform other Asian currencies as the PBoC is more likely to prefer for a stable currency.