China: the virus, the economy, the markets

The Chinese market has held up remarkably well since this crisis began. In fact, it’s one of the best performing equity markets globally, which is perhaps surprising given that the virus originated there and, indeed, the Chinese economy has always been perceived to be a proxy for global economic growth.

Based on our discussions with company management and speaking with our local contacts on the ground – economic activity has clearly resumed. The hope is that the worst of the virus has passed, and people are beginning to venture out and resume their ‘pre-virus’ lives. Industrial activity metrics are picking up. Experts seem to be predicting that once the initial spike in virus cases subsides, we will then see a secondary spike as physical contact resumes. However, this secondary spike is expected to be less pronounced, given some residual immunity. The charts below show how ‘ahead of the curve’ China is versus other regions, with regards to the virus.

China is almost uniquely placed with regards to dealing with this situation. An incredibly strong government balance sheet and a political framework that engenders a largely compliant population. This has meant that the authorities have been able to take decisions very quickly, with little resistance, regardless of how potentially unpopular these may have been. The government can also match this with financial muscle. The country quickly passed several accommodative monetary and fiscal packages, and what we’ve seen from the fiscal side has been interesting in my view. The tax breaks gave people more cash, but broadly speaking the cash has been saved – a reflection of the lockdown (essentially postponing the opportunity to spend) but also of an inbuilt propensity to save in China where there isn’t a social safety net and where savings rates are much higher than in developed economies. This cash windfall, therefore, doesn’t necessarily help protect the economy immediately, but is what we consider deferred consumption. The most economically-challenged sectors in China are the same as we see across the board – hospitality, transport, materials and energy – but, as we’ve seen in the past, China’s control over its entire financial system can be hugely effective in preventing a total economic collapse.

It’s widely accepted that China was the first country into this crisis and is now emerging from it. As such, it is ahead of the west with regards to COVID-19 cases and economic recovery. Yes, we will likely see a significant economic downturn in China this year, but most commentators are forecasting rebounds from the third quarter onwards.

From a market perspective, let’s have a look at the relative performance of some regional market indices:

The TOPIX in Japan represents all the domestic common stocks listed on the Tokyo Stock Exchange First Section. In Hong Kong (HK), the Hang Seng Index consists of a mixture of HK companies as well as some HK-listed Chinese companies – ‘H’ shares. The CSI 300 Index is a pure China index capturing the largest 300 stocks listed on the Shanghai and Shenzhen stock exchanges – ‘A’ shares. The MSCI China Index includes ‘H’ shares, ‘A’ shares and Chinese companies listed in the US (ADRs¹).

As we can see, the domestic market (CSI 300) has performed much better in relative terms since its January peak. The MSCI China Index, which is perhaps more representative of what international investors can access, is down around 20%, putting it comfortably ahead of the wider emerging markets universe (MSCI Emerging Markets), as well as Asia (MSCI Asia Pacific ex Japan) and Japan (TOPIX).

Why is this?

Firstly, the Chinese market is one of the more domestically-focused stock markets in the world, with around 90% of revenues being generated by companies that are domestic in nature.

Secondly, Chinese indices (excluding the ‘A’ shares/CSI 300) are very heavily skewed towards two stocks, Tencent and Alibaba (listings in HK and the US), which account for about a third of the index, and have performed very well. These companies are online consumer businesses; primarily gaming and social media in the case of Tencent, and e-commerce for Alibaba. Business models that, while not immune to these troubles, are reasonably well suited to a ‘lockdown’ situation. These two stocks distort the headline moves we see for the indices. However, if we look beyond those two names, most companies and sectors in China have behaved better than their developed market peers; reflecting the swift corrective action taken through the crisis, and a technical factor – the ‘A’ shares market is only really available to domestic investors. Chinese domestic investors have few places to put their money – they cannot take it out of the country so, given the fiscal windfalls they have received, it is very likely a lot of it ended up going into the stock market.

We can also see in the chart below the changing composition of the Chinese market through time – it’s much less ‘cyclical’ than at any time in the past, with minimal energy or materials weights. This, again, speaks to its resilience through this market downturn.

China remains at valuations quite a way above previous trough levels – however, we should reference the graph above which highlights how companies on the Chinese market today are very different than in the past. Looking at the MSCI China Index on a 12-month forward price-to-earnings (P/E) basis, the market is 32% above the level it was when the tech bubble burst, and it is 40% more expensive than it was at the trough after the Global Financial Crisis – meaning that, in aggregate, it currently trades on a forward P/E that is 34% above its average trough valuation².

Given China’s resilience through this period, value-conscious emerging markets (EM) investors could look to take some profits in these more resilient stocks, and recycle the proceeds into other parts of the EM universe, where we’ve witnessed very large share-price falls. As ever, discerning stock selection remains key.

¹ ADRs = American depositary receipts

² Source: IBES, MSCI, RIMES, Morgan Stanley Research. Data as at 12 March 2020


The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.