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Stephen Nguyen, CFA | 30 March 2020

China's recovery

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We are living in unprecedented times, with much of the world under lockdown due to COVID-19. There are a multitude of potential outcomes resulting from the increasingly extreme global measures being taken to prevent its spread and of course many unanswered questions regarding the lockdown exit strategy or how it all ends. While we are yet to change our portfolios allocations materially, we are making evolutionary changes to the underlying holdings to emphasise balance sheet strength. It doesn’t presently seem appropriate to add significantly to portfolio risk: we stick to our unwavering belief that a well-constructed diversified portfolio is the most efficient way to achieve longer term outcomes. Nevertheless, it is instructive to sketch positive scenarios into our outlook and where better to look for inspiration for a positive spin on events than China, which was the first country to go into full lockdown at the end of January. What can we learn and more importantly what can we expect?

The draconian measures taken by the Chinese authorities in late January have shown promising results in tackling the spread of the virus. While the rate of infections has been accelerating globally, China has seemingly managed to keep it contained, with only a few cases reported in the last week, almost all of which were people entering the country from overseas. Shanghai has had no reported cases for fourteen consecutive days. This is a highly encouraging result and one from which western countries can draw great hope, although there’s always a degree of scepticism about the accuracy of statistics released by China. The extent to which citizens in the west comply with similar measures will have a major impact on slowing the spread of the virus and determine how long it takes for normal activity to resume.

China is beginning to lift restrictions and activity levels have materially recovered. Anecdotal evidence points towards higher footfall on the streets of Shanghai and other major cities plus rising traffic levels: traffic flow on both highways and business districts is widely reported to be reaching 70% to 80% of its pre lockdown level. It is reasonable to expect China, the original epicentre of the COVID-19 crisis, to be ahead of the curve in dealing with the outbreak and that it will likely lead the way in the economic recovery once the storm passes.

Around the globe, governments have aggressively implemented lockdowns while offering unprecedented levels of stimulus from central banks (President Trump has just signed the largest stimulus package in US history worth $2 trillion) to support economies and keep financial markets operating effectively. As a result, we have strong reasons to believe the massive but temporary economic shock will be overcome.

Financial markets tend to reflect changes in the outlook for economies and corporate earnings well ahead of fundamentals and this should mean that most of the negative news is largely ‘priced in’ today. Barring a significant worsening of the virus’ impact such as an uncontrollable wave of second and third round infections, markets have the potential to recover strongly from current levels.

The Chinese equity market has been a perfect example of this. The market bottomed at the beginning of February around the time the spread of the virus peaked there. It subsequently fell further in the following weeks due to the weaker outlook for growth outside of China, but as of today it is still by far the best performing major market globally year to date.

We are not epidemiologists and have no edge in forecasting how the pandemic will play out, but what we can say and are observing is that market participants have moved to discount a Global Financial Crisis (GFC) style outcome for many risky assets. But this is not 2008; we do not have a financial crisis today (and the powers that be are doing their best to prevent one), and we are optimistic that with continued preventative measures in place, the outbreak will be brought under control. A recovery is a matter of when and not if, and while it is futile trying to pick the exact turning point, we know that markets are likely to move higher in advance of any economic and humanitarian recovery.

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