A-shares outperform as the outbreak wanes in China

As the coronavirus spreads around the world, concerns over a fragile global economy have been heightened. Accordingly, in the past few weeks, global markets have turned to a “risk-off” mode despite central banks announcing interest rate cuts and other easing measures to arrest the panic selling.

Of all the affected countries, China appears to have been one of the first to get the virus under control. Since implementing tough isolation and aggressive preventive measures in the past two months, China has seen a significant drop in infections – from hundreds of cases per day in February, to less than 50 per day this week. At the time of writing (23 March), 72,841 out of 81,602 cases have been discharged, and 292 out of 338 cities have indicated zero infections for the first time since nationwide reporting began in January¹.

A series of monetary-easing measures, such as reducing interbank borrowing costs to their decade low, has been employed to ensure ample liquidity in the market. One result of this has been China’s A-shares outperforming other regional equity markets year-to-date (see Fig. 1).

Fig. 1: China A-share market outperformed major equity markets year to date²

For China, that new cases of the virus have peaked is a positive sign. According to Nomura Research, the economy is starting to normalise, as evidenced in the pickup in daily coal consumption of major power plants and the increasing “return rate” of workers after the Lunar New Year (see Fig. 2).

Fig. 2: Cumulative returning rate of workers and daily coal consumption³

That said, China still faces potential external shocks. The surge of coronavirus cases in the rest of the world presents great challenges to the global economy and supply chains, with the outlook currently remaining unclear.

Against this backdrop, we expect more supportive policies to be rolled out by the Chinese government, including more infrastructure projects, targeted favourable policies towards small and medium-sized companies, and further cuts in required reserve ratios and policy lending rates.

Considering all this, we expect China’s GDP growth to be between 4~5% this year, which corresponds to an earnings growth in the A-share market of approximately 1% to 4% respectively. We also believe that China will continue to foster new sectors of the economy, which includes 5G, healthcare and new consumption, amongst others (as we discussed in “China A: Short-term volatility creates good entry point for long-term investors”).

Currently, valuations appear supportive in the China A-share market. The forward price-to-earnings ratio of the CSI 300 index, trading at 9.5x, is sitting below its 3-year historical average (see Fig. 3) and it is also much lower than its global peers, with the MSCI World Index trading at a forward P/E of 12.3x, according to Bloomberg consensus.

Fig. 3: The forward price-to-earnings ratio of China A-shares is significantly below historical average⁴

In the near-term, the gloomy global growth outlook, coupled with falling risk appetite in global markets, will inevitably weigh on A-share market sentiment. In the longer-term, however, the trend of a structural shift in China remains intact.

At Eastspring China, our Shanghai-based equity team will focus on sectors that have limited overseas exposure and which can benefit from domestic pro-growth policies, as well as those coronavirus-insensitive sectors that can still deliver decent growth for 2020.