Tuesday 28 January 2020 6:04 am

Year of the Rat: How China's coronavirus outbreak is spreading tremors through world markets

Saturday marked the beginning of the Year of the Rat. This animal — representing the first of the 12 signs of the zodiac — is associated with wealth and prosperity in China. 

In other cultures, the rat is more often associated with plague and disease. It is unfortunate, then, that the dominant Chinese story this new year has been the outbreak of a health epidemic: the coronavirus.

At the time of writing, 81 people have died from the disease, and there have been almost 3,000 confirmed cases in China. A further 44 cases have been recorded abroad in places including the US and Australia.

The outbreak could have serious consequences for China’s economy. Tourism is likely to be dented, with fewer people willing to travel to the country due to the risk of exposure. Consumption will also take a hit, as Chinese citizens who fear contracting the disease will be less willing to go out and spend money. 

China is the world’s second largest economy, so any economic weakness there will impact the rest of the global financial system. Stock markets in the US and Europe are already falling as fears rise over the spread of coronavirus. Rupert Thompson, chief investment officer at Kingswood, says that the virus has provided a catalyst for a market setback.

“The US market was down on Friday, and the UK and European equity markets fell around two per cent on Monday,” he says.

“The coronavirus has provoked comparisons with the SARS virus back in 2003, which ended up with close to 800 people losing their lives. That outbreak hit Chinese growth and the Chinese equity market significantly, but the impact was short-lived with both rebounding within a matter of months.” 

This outbreak comes at a difficult time for China. Its economy in 2019 grew at its slowest pace in 29 years, expanding by just 6.1 per cent according to official figures. 

This slowdown is partly the result of the trade war with the US. While the two nations recently signed the first phase of a trade deal, tariffs on goods worth billions of dollars are still in place, further stymying growth.

With all this in mind, investors would be forgiven for taking a risk-averse stance on China. But while we cannot predict how great the overall impact of the virus will be, there are still reasons to be cautiously optimistic about China’s economy in general.

“The slowdown has been more of a glide than a sharp fall, and it is important to recognise that the relative rate of growth we see in China is still significant when compared to the west,” says Dale Nicholls, portfolio manager of the Fidelity China Special Situations fund. 

“Moreover, a number of areas related to domestic consumption are still growing rapidly, as domestic demand continues to play an increasingly important role in driving overall economic activity in China.” 

There are other positive signs ahead, according to Nicholls, with the Chinese government taking more action to stimulate the economy. Mike Kerley, manager of the Henderson Far East Income fund, agrees that there are reasons to be optimistic.

“The optimism is based on improvements in China and the positive impact this will have on the rest of the region,” he says. “Unlike previous cycles where the Chinese response to domestic or external challenges has resulted in a splurge on debt-funded spending, the response through 2019 has been much more pragmatic. Cuts in interest rates and bank reserve requirements have increased liquidity and access to credit, while tax cuts and state-owned enterprise reforms have stabilised consumption and increased the productivity of the most inefficient parts of the economy.” 

He adds that recent manufacturing and services data suggests that, if you take the coronavirus out of the picture, the worst is behind China and economic expansion is possible in the quarters ahead.

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Given these positive signs, what is the outlook for China’s stock market?  

“Chinese equities are looking attractive from a valuation point of view — with mainland stocks trading below historical averages,” says Emma Wall, head of investment analysis at Hargreaves Lansdown. “In fact the cyclically adjusted price-to-earnings ratio — a measure of value often used to predict long-term market returns — suggests that investors in mainland China stocks could double their money over the next 10 years.”  

Kerley’s advice to investors considering the region is to first check what China’s government is planning. 

“Every five years, the Chinese government issues a five-year plan which details strategy, objectives, and industries which will receive government support, while identifying those that need restructuring or restriction,” he says. 

“Unlike most political manifestos, this plan is adhered to almost religiously and gives a clear indication of where government policy will be most supportive. Therefore, the sector in which a company operates is more important than whether a company is owned by the state or privately. This should be the starting point for investors looking at companies in China and whether you are investing alongside or against the state objectives.”

Ian Hargreaves, co-head of Asian and emerging market equities at Invesco, shared his view on the investment case for China.

“We have not been bullish in our top-down view on China for some time, but that does not preclude us from finding great investment opportunities there, particularly in consumer-related companies,” he says.

“As valuation-led investors with a long-term investment horizon, we remain focused on investing in companies that are worth more than the market believes. Our portfolios continue to have significant exposure to highly cash generative internet companies, but more recently we have seen opportunities emerge in other sectors — such as autos and beverages — with valuations in some cases reflecting what we consider to be significant discounts to our estimate of fair value.”

China’s stock markets will not reopen until 3 February, as the authorities have extended the Lunar New Year public holiday, so we have yet to see how Chinese share prices will be affected by the outbreak. But there is a chance that the Year of the Rat may still prove to be a profitable one. While the coronavirus has been dramatic, the fact is that global health epidemics are unpredictable — this could be resolved in a few days, or it could hit other economies across the world. 

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Main image credit: Getty