Health check: the coronavirus’s impact on Asian economies and markets

Mask person
A Q&A with David Chao who is keeping track of the coronavirus outbreak’s impact by looking at economic indicators across the region.
Q1) What impact does the coronavirus outbreak have on the Chinese economy?

The most recent data from China1 shows that new confirmed coronavirus cases outside Hubei province have fallen, recovery rates have improved and attention has now shifted towards resuming normal business activities. Although we are not out of the woods yet, as the coronavirus continues to escalate in other parts of the world, the new infection cases in China has already peaked – the central government has recently relaxed a few transportation restrictions and called for the economy in the coastal areas to resume production.

The economic pain from the coronavirus will be felt most acutely in Q1, but if we look at structure of Chinese economic activity, Q1 has historically seen the lowest economic activity around 24% versus 28% in Q4 of the full year (Chinese New Year holiday, build up for Christmas, new product launches in Autumn).2 For example from 2016 -2019 in Q1, the Chinese domestic construction sector accounted for only 13% and the manufacturing sector accounted for 22% of the full year.

In order to gauge any rebound in economic activity, investors can track the daily traffic congestion index, coal consumption of six large power plants and even property sales in 30 major cities. Although each measure remains subdued, expectations are for economic activity to slowly ramp-up at the end of this quarter – already a few electronics hardware manufacturers and many large state-owned enterprises (SOEs) have resumed normal business activities.

I expect economic activity to normalize some time in Q2. We expect a V-shaped recovery in the Chinese economy since a meaningful component of activity will be postponed to later in the year, such as construction, large consumer item purchases and capital expenditures.

On the other hand, permanent economic losses in Q1 will come from a decline in domestic consumption and services – which now makes up a majority of China’s GDP. Chinese household consumption and its related economic data (as measured by monthly retail sales) will take a significant dip in Q1 with offline consumption falling but mitigated somewhat by online consumption (which was less important 17 years ago during SARS). However this part of the economy is expected to pick up significantly once the transport lockdown eases – which it is starting to in certain parts of China.

We assume that the coronavirus outbreak in China will be controlled by the end of Q1 to beginning of Q2 2020 and we continue to closely monitor the daily infection rate and commercial activities to assess the economic impact. To help buffer against downside economic activity, the government has eased monetary policies through interest rate cuts and brought forward fiscal stimulus policies in the form of tax waivers and subsidies.

Q2) What major impact will there be on other economies in the region?

Outside of mainland China, the major markets that are likely to be impacted are Hong Kong and Thailand, where inbound tourism is a significant portion of GDP and mainland Chinese tourists make up a significant portion of the overall mix.

Chart : Thailand and HK are both heavily dependent on tourism
Figure 1
Source: Gavekal Data/Macrobond, February 2020

Hong Kong’s economic growth in the past few years has, to a large extent, been driven by inbound tourism from the Mainland, as close to 10%3 of the economy now depends on tourism and around 75%4 of tourists come from the Mainland. Travel and retail operators along with Hong Kong’s real estate developers are the most exposed and impacted the most.

I don’t see Hong Kong’s economy and equity market to be as severely impacted as they were during SARS in 2003. For example, if we analyze the housing market and closely look at the Hong Kong real estate developers, the long-term fundamentals are still solid and company balance sheets have conservative leverage on a debt/EBITDA basis when compared to 2003. Although the housing and commercial real estate sector will be under pressure this year, I don’t expect meaningful downward price adjustments from here as the overall housing sector is much more healthy compared to 17 years ago: fewer households are exposed to the peak of cycle due to higher down payments having been paid and continued low interest rates (versus the last downward cycle that was triggered by rising interest rates). So far, households have not been under pressure to sell their properties – which indicates that the majority of Hong Kong bank’s credit quality remain healthy.

As for Thailand, its economy is more dependent on tourism and the Bank of Thailand (BOT) recently cut its benchmark rate to help cushion the economy from the fall in Chinese tourists. Thailand has had a robust current account surplus because of the strong inflow of foreign tourists which has pushed the local currency Thai baht (THB) to be one of the strongest performing currencies against the USD. The strength of the THB has been a headache for the BOT as it harms Thai manufacturing exporters – the silver lining from the coronavirus is that is has weakened the THB and helped Thai exporters by making their goods cheaper to export.

A scenario analysis shows how a fall in Chinese tourists could weigh on Asian economies. The chart below shows how, in the event of a 30% and 80% decline in tourist arrivals from China could impact GDPs of selected Asian economies.

Chart: Impact on GDP under different scenarios of Chinese tourist numbers
Figure 2
Source: Gavekal Data/Macrobond, February 2020

On the other hand, Asian economies less dependent on exports such as India, Indonesia and the Philippines will be less affected by China's fall in demand.

Q3) What is your outlook for the broader Asian markets?

Fundamentals in Asia continue to be intact and strong. That’s why I continue to be broadly supportive of emerging markets (EM) Asia risk assets, including equities and high-yield bonds. This is because:

  • Monetary policy remains accommodative with plenty of room for rate cuts if needed as real policy rates are still positive and above historical average. Asian central banks have eased policies this month (e.g. Thailand has cut rates to record low) – interest rate cuts are the low hanging fruit for central banks.
  • Asia inflation (around 2-3%) is more in line with developed markets than non- Asia EMs (about 8%).5
  • Earnings growth is looking good at 16.4% yoy.6

China’s growth and its transition story to becoming a consumption-led economy is still happening, while core activity such as manufacturing has already showed signs of an initial turnaround.

Chart: Sign that Asia's electonics trade was turning
Figure 3
Source: Gavekal Data/Macrobond, February 2020
Q4) Amid the coronavirus outbreak, what are you taking into account?

Corporate sentiment in China and the rest of Asia continues to fluctuate around cautious optimism, as measured by the most recent PMI around the region.7 The continued positive sentiment from the end of last year to the beginning of this year comes from the corporate capex cycle’s bottoming out and subsequent recovery, the significant uncertainty and overhand being removed from the signing of the Phase 1 deal and overall inventory restocking.

Despite the relative optimism, I will be closely watching the February PMI data in Asian countries to see if there’s any deterioration due to the coronavirus. Remember that China did not release any trade data in January, instead choosing to release the monthly data with the February data.

As for supply chain disruption in Asia, we are watching this very closely as the coronavirus spreads to places like South Korea. Already, we have seen certain companies in the auto and electronics industries announce temporary closures.

On the other hand, Chinese factory workers have slowly started to return to work as of mid-Feb and I expect this pace to quicken over the coming few weeks. Notably, I don’t expect to see any permanent shifts in supply chains away from China as business leaders have for the most part have viewed the coronavirus as an idiosyncratic headache rather than a game changing catalyst.

Another very important positive catalyst that we are looking out for is the electronics industry inventory re-stocking and deployment and roll-out of 5G infrastructure in the 2H of 2020, which will start a fresh replacement cycle.

Market and investment implications

Investors can continue to expect global market volatility and gyration due to reports of the coronavirus spreading. There is downside risk to equities especially in developed markets like the US where the S&P recently hit an all-time high. Although the new infection cases in China appears to have started its path towards remediation, there are other pockets of contagion around the world that will cause near-term market anxiety.

In order to counter economic risks and slowdown, central banks around the world continue to be in a synchronized monetary easing mode, which explains why investors remain in a risk-on mode and risk assets have performed well year-to-date. This is the first time since 2008 that almost every major central bank around the world is easing either through interest rate cuts or pumping liquidity into the system. Already this year, we have seen central banks in China, Mexico and Thailand cut their benchmark rates. Other central banks are set to follow in place like Indonesia, Korea and India.

In addition, governments such as India and China have taken the extra step to boost domestic demand through fiscal stimulus in the form of tax cuts. Loose monetary policy coupled with fiscal stimulus tends to boost economic activity and is correlated with improving corporate earnings and decent risk asset performance. Any material downside risk to risk assets is somewhat buffeted by expansionary monetary policies taken by central banks around the world.

We think that the coronavirus may depress markets, and that could uncover bargain opportunities for a limited time only, as markets can very quickly bounce back once investors shift their focus back to Asia’s attractive valuations and strong longer-term growth fundamentals.

Although the 2020 economic horizon has been clouded by the coronavirus, I continue to expect 2020 corporate earnings to be strong on a year over year basis. The coronavirus is a near-term negative catalyst that puts a damper on economic activity and corporate earnings, however once this cloud dissipates, I expect commercial activity to normalize.

For the rest of 2020, it’s important that investors examine the economic fundamentals in Asia – and I argue that they are meaningfully improving from last year. I continue to see an earnings and growth recovery led by the manufacturing and trade sectors. In the second half of 2020, we will start to see the positive impact from the semiconductor industry cycles ramping up, companies re-stocking their inventories and the emergence and commercialization of 5G technologies and the robust impact it will have on Asian electronics and technology companies.

Chart: Valuation appear more attractive outside the US
Figure 4
Source: Gavekal Data/Macrobond, February 2020
Q5) Which markets do you prefer?
  • We continue to like emerging-market (EM) Asian equities which trades at attractive multiples (valuations) especially when compared to the developed markets (DM) such as the US and Europe;
  • We prefer EM Asia equities over fixed income; Asia EM equites have returned on average about 7-9% real yield over the past few years, whereas Asian EM fixed income net yields right now are close to 0;
  • For fixed income, we think that DM government bonds are very expensive and continue to prefer Global Investment Grade and High Yield credit;
  • In alternatives, we like income-generating assets such as real estate for diversification.
Q6) Apart from coronavirus, are there any other risk factors that you are looking out for?

The global economy remains pretty healthy, particularly in the US where unemployment is very low and wages are rising.

However, the US election is a driver of uncertainty this year. Bernie Sanders has been performing strongly and may end up as the Democratic nominee – I don’t think markets have priced in this possibility.

David Chao is Global Market Strategist (APAC) at Invesco.

^1 Source: National Health Commission of the People’s Republic of China, Feb. 17, 2020.

^2 Source: CEIC. Data as of Feb. 3, 2020.

^3 Source: Gavekal Data, as of Feb. 16, 2020.

^4 Source: Hong Kong Tourism Board, latest figures as of Dec. 31, 2019.

^5 Source: Bloomberg, as of Feb. 5, 2020.

^6 Source: Yardeni Research, Feb. 12, 2020.

^7 Source: Trading Economics, as of Feb. 17, 2020