2020, the year of the Rat, according to the Chinese zodiac, could mark the dawn of a new day.
The last time we saw the year of the Rat was 2008, the year of the Great Recession, when quantitative easing became the new norm and investor expectations were reframed. China, the epicentre of the current pandemic, is seeing early signs of regular economic activity resuming, following a substantial setback to GDP of -6.8% in the first quarter. Industrial output increased in April for the first time since the virus outbreak, up 3.9% in April year-on-year, beating expectations of a 1.5% rise. Coal consumption at power plants is approaching 2019 levels, suggesting China’s supply chain is approaching normality. China’s experience suggests that a modest easing of COVID-19 restrictions can produce a substantial initial bounce in productivity.
Retail sales, however, contracted 7.5%, higher than the estimated fall of 6%, which may cause some concerns around reliance on China’s middle class coming to the rescue of an enduring recession. Last year consumer spending accounted for 58% of China's growth. Following the 2002-2003 severe acute respiratory syndrome (Sars) outbreak, retail sales growth in 2003 fell from 7.7% in April to 4.3% in May, when the outbreak was at its worst, and bounced back to 8% in June when the virus was contained. The noticeable difference this time around however, is that consumers are in lockdown and consumer sentiment is dramatically weaker.
Chinese consumers have typically also been big spenders whilst on their travels, whereby $277.3 billion was spent in 2018 during overseas trips, an increase of 5.2% compared to the previous year, according to the World Tourism Organization. Hong Kong International Airport, the world’s busiest airport for 9 consecutive years, saw 32,000 passengers travelling through the airport in April, which marks a decrease of 99.5% compared to the same month last year.
Luxury brands are under the spotlight, a sector which held its own in 2008. A range of industries are currently experiencing sharp declines, largely due to store closures. Nevertheless, many of them are adapting. Only 5% of new luxury watch sales are from online purchases, yet most brands have turned to digital channels, particularly social media, for example Omega’s Speedy Tuesday Live and Zenith’s On Air, giving consumers direct access to brand executives and partners. Shanghai Fashion Week, was also streamed live during the lockdown on Tmall, an online retail platform operated in China by Alibaba Group, allowing consumers to buy what they see. These channels connect consumers to real-time events, whilst offering seamless inspiration-to-purchase processes.
Healthcare is also becoming the new luxury, as mental wellbeing, organic products and virtual personal training sessions become the new craze.
The verbal attack by President Trump on China marks the resumption of the trade wars, or rather a modern-day cold war. His criticism of China’s approach to addressing Coronavirus along with a threat to “terminate” the trade deal due to uncertainty over China’s willingness to honour its pledge to buy American goods, marks a step further away from globalisation, whilst also timely ahead of a US election. China was projected to increase purchases of U.S. farm goods by at least $12.5 billion in 2020 and $19.5 billion in 2021, yet we may also see a reduction in its US Treasury reserves in response to the trade tensions. This selling pressure could lead to further increases in the dollar, making it uncompetitive internationally.
The PBOC has already rolled out a number of easing measures since early February, including cuts in reserve requirements and lending rates, and targeted lending support for virus-hit firms to keep business alive, and help promote consumer sentiment. The central bank will continue to deepen the reform of the loan prime rate (LPR) regime and continue to lower borrowing costs to kickstart demand.
Emerging market funds have seen substantial losses over Q1, with some big names such as M&G Global Emerging Markets and Lazard Emerging Markets returning -28.06% and -25.64% respectively (-9.69% and -7.27% versus the MSCI Emerging Market index).
Some fund managers have however, seen the sell off as an opportunity, as allocations to Chinese stocks among more than 800 funds reached 25% of their $2 trillion in assets under management, representing an increase of 20% from a year ago, according to EPFR.
For those allocating to the broader Asian region, where might they find companies that can weather further volatility? Asian dividend stocks have historically outperformed the broader region after previous sell-offs, whilst maintaining steady payouts, including firms like chipmaker TSMC (which paid out US$8.4bn in dividends last year), which supplies chips to the likes of Apple, Nvidia and Qualcom. Payouts within mainland China have been supported by Government calls to increase shareholder returns, particularly in the form of dividends. State-owned enterprises (SOEs) with strong cashflows have been big dividend payers typically within financials, energy producers and real estate developers. Many of them have strong balance sheets that allow resilient distributions. Many dividend payers will come under pressure, similar to that seen from global peers, and therefore investors must focus on companies with strong balance sheets.
It is also important to distinguish those companies with strong fundamentals and governance structures, as cheap money can encourage malpractices for example Luckin Coffee, the Chinese equivalent of Starbucks, recently disclosed a fabrication of $314 million in sales, leading to a share price plunge of more than 80% before stocks were suspended. A focus on mainland Chinese A-shares can also mitigate some risks from U.S. - China trade tensions.
Integrating diversifying strategies, such as gold miners can also be beneficial. 2020 is specifically the year of the metal rat and despite gold’s rally year to date, can still add value in a negative yielding bond environment, and will hold its value should the Fed successfully decrease the value of the dollar. Gold relative to the S&P500 is at record low levels.
Emerging markets and in particular China remain important allocations within portfolios, providing diversification of revenue streams and sectors, and can be played at a thematic level such as consumerism or cashflow generative dividend payers. The modern era cold war, in the form of tariffs and currency devaluation, is expected to continue into the foreseeable future, however companies have already started adapting to the new norm. Whilst early signs are looking positive, time will tell whether we are in the midst of a dead cat (rat!) bounce.
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