Do not underestimate the virus outbreak’s negative impact to the real economy, while capital markets boosted by ample liquidities.
- We think the negative economic impact from 2019 nCoV outbreak will be greater than SARS in 2003.
- Optimistic scenario (40% chance) is that the outbreak will reach its peak in next week. Under this premise, the economic losses will be limited and the domestic stock market can retrace all the losses since the Spring festival.
- Base case scenario (50% chance) is that the outbreak will continue with the confirmed infected patients outside of Hubei Province peaking after March. This will bring big impacts to domestic consumptions and industrial outputs. The whole year’s GDP growth will slow down to 5%. The Shanghai Composite Index will trade between 2600 and 2900 in the 1st half.
- Under all scenarios, demand for commodities related to domestic discretionary consumptions and property markets will suffer during the 1st half. The supply chain for some commodities also needs time to restore. Under base case scenario, the demand recovery in 2nd half may also have downside risks.
- We are more optimistic on growth stocks in new economy and high-tech sectors in A share, as they are less sensitive to the macro data and short term earning downside risks.
Straits Financial (China) Chief Strategist
Hello! I'm Hou Zhenhai. I'm very glad to present to you our monthly column - “Strait Financial Chief Commentary”. Here we will discuss recent market-focused macro & strategy topics. We hope to hear your views and suggestions. Thank you!
The most important macro question is obviously the globally focused outbreak of new coronavirus(2019 nCoV) in China. So we first look into its potential impacts on China’s economy and capital markets.
I. We think this virus outbreak will have a severer hurt on China’s economy than the SARS in 2003.
Due to the similarity between these two viruses, many economists and market participants tend to use the 2003 SARS as a comparative indicator to analyze 2019 nCoV’s economic impact now. But we do not believe this is a proper comparison. Except for some biological similarities in the viruses, China’s economic situation now is totally different from 17 years ago. So we believe the economic impact will also be quite different. Showed in Chart 1 below, we can see the SARS in 2003 had a severe impact to the total passenger turnover, which dropped yoy in 5 consecutive months from April to August. The biggest drop was over 40% yoy in May 2003. I think this may also be the case this time, but we can also find that cargo turnover in 2003 suffered a much less impact during the same period, with lowest growth in 0% in May, just followed by a significant and fast rebound touching a new high of 20% yoy in the 2nd half 2003. Moreover, 2003 saw a very stable Industrial Outputs growth the whole year. This means that SARS did not have any big impacts over China’s outputs.
But this might not be the case this time. Why? I think this is largely due to the much different economic structure and global economic environment between now and 2003. In 2003, China’s service industry was only 39% of its GDP, while currently is 54%. That means the domestic consumption loss will have a bigger hurt to the economy now. More importantly, 2003 was the second year since China’s entry into WTO. The total export growth in 2003 was 35% yoy (see Chart 2 below). The robust foreign export demand contributed almost 40% of the GDP’s growth in China then. Meanwhile, during that time the majority export goods from China were primary processing products like textiles and machinery parts, while usually had both raw materials and final demand markets overseas. Their local processing industrial chains were short and simple, therefore, as long as the global shipping remained, the breakdown of local transportation only had a very slight impact to the industry and economy.
But now China’s industrial outputs mostly cater for its domestic demand and mainly produce much more complex products including consumer electronics, automobiles, precision instruments, high-tech equipment, etc. These products mostly need complex cooperation and long supply chains to make, and many of these supply chains include inland domestic provinces. So the breakdown of domestic transportations, though it may temporary and regional, will induce much severer and more sustained economic losses.
II. Scenario analysis of the 2019 nCoV’s future impact on economy and markets.
I think there are 3 scenarios.
- Optimistic scenario is that the virus outbreak will reach its peak in mid February and number of newly confirmed infected patients outside of Hubei Province will gradually drop and disappear in March. I think the chance of this scenario is about 40%. Under this premise, the overall impact to China’s economy will be mostly contained in the Q1. Since Q2, with impairment of the symptom and more expected stimulus policies, the economy growth will gradually recover. I expect the whole year’s GDP can maintain about 5.5% growth.
- Base case scenario is that the outbreak will be with us for another month and peak after mid March, which means that the overall time of outbreak will be roughly same as SARS. I think this will have a 50% of chance. In this scenario, even with more monetary and fiscal stimulus, the economy growth is likely decelerating to 5% with household consumption and industrial outputs returning to normal not anytime before Q3.
- There is a 10% of chance in a most pessimistic scenario. This can only happen if the outbreak deteriorate further as the virus mutates for the worse or outbreak spreads outside of Hubei Province. This will have a major threat to China’s economy as it may put a turning point to the household debt leverage and property market. But this possibility is slim under very strict controlling measures taken all over the country now.
III. Capital market impacts
- Under the optimistic scenario, I think the production and transportation will need another month or so to restore gradually. But consumption demand will need 3 months time to be normal. The demand for relevant commodities will still suffer during the 1st half. But the impact will be limited in the 2nd half, and some commodities may enjoy “compensatory demand” then, but it may not be as strong as it was in 2nd half 2003. For domestic stocks, the Shanghai composite index will likely retrace all the losses incurred after the spring festival, but the further upside after that will be limited.
- The base case scenario will bring a longer term demand shock to most of the commodities, especially those closely related to household discretionary consumption and property markets. Certain industries such as hotel and restaurant, travelling and tourism, commercial properties, non-internet entertainment business, etc may incur financial strand or even breaks. Under this scenario, the Shanghai Composite Index may not go beyond 2900 in the 1st half and could be go as low as 2600. However, provided this scenario, investors should also pay close attention to the future measures and stimulus taken to support the economy, including but not only monetary and fiscal policies. When the market becomes over confidentt about the economic recovery, it is better to take profits on risky assets.
The most pessimistic worst case scenario is of very low chance so that I think the market will NOT trade that possibility unless there are solid evidences to certify the 2019 nCoV outbreak is out of control nationally. However, we may still need to keep an eye on it.
For the Chinese domestic stock market, as the short term economy will certainly suffer no matter how long the outbreak can be contained, the market’s expectation for an economic recovery in 2020 will be greatly tarnished. However, the expectations for more liquidity loosening and policy stimulus will heat up. This will mostly help the growth stocks in so-called new economy and high-tech sectors. Meanwhile, stock names in those sectors have relative low correlation with the macro economy data and short term earning trends, so I think they may outperform in the near term. Moreover, except the worst case scenario, the outbreak’s overall impact to the US stock market will be quite limited.
About the Author
1998 – 2004, Chief Representative Assistant of GKN Group in China.
2006, obtained MBA degree from Wisconsin School of Business at University of Wisconsin–Madison.
2006 – 2007, served at the Wisconsin Foundation.
August 2007 – July 2013, served at China International Capital Corporation (CICC) as the leader of the overseas strategy team and A-share strategy team. He is also the main report writer and contributor. Mr. Hou and his team received many honors including the top team for the New Fortune Sell-side Strategy Research in 2008, and the top team for the Asia Money China Strategy Research in Hong Kong in 2009 and 2012, etc.
September 2013 – December 2019, served at Discovering Group and was responsible for the Group’s macro strategy research. During the period, the company has accumulated absolute returns that far exceed the market level.
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