This is the second update in our special series on investing at what can be a challenging time for investors.
Last week, UOB Asset Management (UOBAM) updated our investment views following the Novel Coronavirus (2019-nCoV) outbreak in mainland China, with no change in our asset class positioning. Our key message was that the history of viral outbreaks points to potentially significant market drawdowns in the first couple of months following an outbreak, but a complete recovery may be expected when the number of cases starts to decline convincingly. We put forth the 2019-nCoV outbreak should be considered to be at least as serious as the severe acute respiratory syndrome (SARS) in 2003, and that it is likely premature to chase for value in the market corrections.
The spread of the outbreak has continued to be aggressive this week and markets have continued to be volatile with sharp declines on Monday and a partial rebound on Tuesday. Our investment views remain similar. Our base case is that similar to other virus outbreaks, we believe it is likely that the number of cases resulting from the virus will taper off over the next few months. As the weather warms, the prevention actions are likely to have more success and a breakthrough in the vaccine may become more prevalent. When the outbreak tapers off, there are likely to be market opportunities, but before then it is still likely that the number of cases and the anxiety over the virus may get worse before it gets better. For now, we still see the number of new cases occurring daily and the threat of the virus breaking out of China remains a significant risk.
What is driving market reactions?
When the Shanghai A Share market opened on 3 February 2020 after the extended Lunar New Year (LNY) break, the CSI 300 Index fell by about 8%, bringing the total correction from the time the outbreak hit to over 11%. We saw 90% of traded stocks fall at the daily 10% limit on that day. This market impact is to be expected as the domestic China market was closed throughout the LNY week when the impact of the outbreak took a major toll on other markets globally. A case in point was the Xtrackers Haverst CSI 300 China ETF listed in the US (ASHR US) which has been trading over the LNY period; it has fallen by about -14% from the time the outbreak scare hit the markets (as of 3 February 2020).
Over the course of this week, markets have been fairly upbeat on the back of efforts by the People’s Bank of China (PBOC) to contain the outbreak and its attempts to ease the economic fallout for China. More central banks indicated a willingness to intervene if the virus poses an economic fallout for their countries. As we have seen with many volatility shocks, investors regain faith and turn risk-on again when they see measures to stabilise the economy.
Despite the investor optimism, we would urge a sense of caution at the same time. The current outbreak has not stabilised as we continue to see new cases reported daily and treatments may still be a long way to go. The economic impact of the 2019-nCoV and China’s preventive and isolation measures are expected to weigh on global GDP growth. We started to see a cut in economists’ forecasts for China’s GDP and consensus GDP growth in China is being downgraded from 6.5% to 5% by most economists. It is worthwhile to point out that China today is a far more significant contributor to the global economy than during the SARS period and even if the outbreak was contained within China, the global GDP growth could fall from 3.2% to 2.9%. Countries throughout Asia are likely to see sharp declines in tourism, transport and logistics and discretionary consumption sectors.
The short-term outlook for fixed income may be positive as China’s central bank relieved pressure on the economy by cutting rates and injecting liquidity into money markets. In the longer term, investors need to watch for fluctuations as returns may slip with the rebound in consumption and investment.
We estimate that the Shanghai A share market could correct by about -15 to -20% in the short term. This market pull-back may be seen as an adjustment in the middle of a late cycle. We will also likely see a similar correction in other Asian markets, due to the region’s economic linkages with China; perhaps to a lesser extent provided the outbreak does not spread widely throughout the region. In the mid to long term, we may see innovation and reform in China’s living habits and governance that would strengthen the country. Following SARS, China’s economic policy focused on fostering new consumption hotspots and growth points. A new round of innovation and emerging industries such as new energy, 5G developments may be spurred by this outbreak to accelerate the growth momentum in China.
UOBAM house view and positioning
SARS, MERS, and the Swine Flu outbreaks all affected markets in the past couple of decades and in these cases, once the number of new cases started to decline, markets fully recovered their losses. But we are likely still to be in the early stages of the 2019-nCoV outbreak. We still expect that the number of cases and overall concerns over the outbreak are likely to get worse before they get better.
We still think it is too aggressive to buy into the market correction at this stage, but overall, we do think investors should remain calm and look for signs that the number of new cases is declining. While headlines of the market volatility may likely be sending mixed signals, we would hold the view that once the outbreak is on a downtrend, global investors will look past weak economic data points during these months as being transitory and will not derail their investment plans.
Hence, we continue to remain neutral in equities and have a slight overweight on fixed income. We also maintain an underweight in commodities and cash and hold an overweight view on alternatives. Within equities, we continue to overweight the US, and remain neutral on Asia at least until the virus passes. For Asian fixed income, we are inclined to turn neutral from slightly positive in Asia credit bonds in view of the outbreak. As of end January, spreads appeared to be at a rather attractive level as the JP Morgan Asia Credit composite spread was 18bps wider than its three-year historical average of 248bps while 10bps wider than its five-year historical average of 256bps. Anchored Asian demand and manageable supply will remain as a favourable technical contributor towards returns for Asia Credit assets into 2020. Overall, we continue to favour the non-investment grade segment as this segment offers a higher carry despite rising idiosyncratic risks. On the duration strategy, we will be staying broadly neutral in overall duration though we may engage in tactical duration positioning.
With regards to currencies, the dampening headlines had led to sell-offs in currencies such as the Singapore Dollar and Thai Baht of open and/or tourism-dependent economies. Correspondingly, the currencies of countries that did not have any confirmed cases of infection like Indonesia performed relatively better. We would stay underweight in at least the Chinese Yuan for the time being, with economic data likely to take a hit in the coming months. We also remain underweight the Singapore Dollar especially after the Monetary Authority of Singapore (MAS)’ dovish announcement on 5 February 2020 that there is sufficient room for the currency to ease if the economy weakens due to the impact of 2019-nCoV.
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