- Undeniably, China's economy has been deeply affected by the Covid-19 in the first quarter, with majority of its recent economic
readings published near historical low.
- Into the second quarter, however, China has entered into the final phrase of its Covid-19 containment, where day-to-day lives of its populace and businesses are quickly returning to normalcy.
- We think China’s
domestic consumption will witness a significant rally, given the pent-up demand from consumers after two months of being grounded at home, which will help offset the expected fall in demand from its external trade partners.
- With the support rendered by policymakers via the series of accommodative monetary and fiscal policies, we believe that growth in the next three quarters will more than make up the weakness in 1Q due to the Covid-19 crisis.
- Our projected China’s GDP growth rate
in 2020 will be V-shaped one, and the overall GDP growth rate for 2020 will be
3.8% in our base case projection.
- Based on our fair PE multiple allotted to China A-shares and H-shares equity markets, we derive an upside potential of +50% and +70% respectively by end-2022.
China's economy suffered damages caused by Covid-19 in 1Q 2020
For China, the outbreak of the highly infectious novel Coronavirus (Covid-19) was an untimely one. It occurred during its Lunar New Year period, in the midst of the annual mass migration of the world's largest population.
In order to prevent a rapid and uncontrolled contagion throughout the nation, given the high volume of human traffic coursing through China via "Spring Festival travel rush", the Chinese government has imposed all draconian measures necessary.
Firstly, Spring Festival holidays were extended. Next, the post-holiday resumption of work were suspended, effectively halted economic activities for all except the most essential of industries. Not only were travel restrictions and city lock-downs strictly implemented, regulators also rigorously examined the resumption work of corporations to prevent the virus from spreading all around China.
The cost for safeguarding its populace from being ravaged by the Covid-19 pathogen came with a huge economical price tag.
As at 27 March 2020, all the published economic data related to its economic development decreased dramatically:
Except for the import and export figures, all the other economic statistics are historical low records.(i) The added value of industrial enterprises above designated was -25.87% year-on-year in February.
(ii) The accumulated fixed assets investment in February was -24.5% year-on-year
(iii) The total retail sales of consumer goods in February was -20.5% year-on-year and the total amount of export and import in February was -11.0% year-on-year.
(iv) Another important leading indicator, China Official PMI, in February was 35.7.
China has entered into the late stage in the pandemic cycle and economic activities are returning to normalcy
Heading into the second quarter, we believe the Covid-19 crisis may have been passed its worst. China is currently at the late stage in its pandemic cycle, where the rate of new infections have peaked and have decline significantly. In fact, its government is now shifting focus toward imported cases, given the surge in Covid-19 cases outside of China (Chart 1).
With the Covid-19 situation reasonably contained within China, economic activities were able to fully resume in March, just two months after the initial outbreak. As of writing, the resumption rate in China was reached more than 97.5%. Twelve provinces and municipalities have achieved 100% resumption rates, and these regions contributed more than half of China’s GDP last year. (Chart 2).
In addition, we see promising signs that China's economic activities are gradually recovering. Firstly, the daily average coal consumption of six major power generation groups in March 2020 was short only a mere 10,000 tons less than last March, and we expect coal consumption to return to normalcy by April (Chart 3).
From the congestion delay index of 4 major cities in China (Beijing, Shanghai, Guangzhou, and Shenzhen), we can also see that the index has almost returned to the level before the pandemic outbreak (Chart 4).
Chart 1: Different Stages of the Pandemic Cycle By Country
Chart 2: The Work Resumption Rate of the Provinces and Cities Nationwide
Chart 3: Daily Average Coal Consumption of Six Major Power Generation Group
V-shaped economic recovery in China's GDP growth ahead
Using current macro data releases and our analysis of Covid-19 situation, we approach the three most important components (consumption, investment and imports/exports) to forecast real GDP growth in a single quarter.
In our base case scenario, we expect that:
Consequently, we expect real GDP to decline by -3% in the first quarter, followed by a sharp rebound in the next three quarters, with growth rates of 4%, 6% and 7%, respectively. Overall, we expect that China's real GDP growth in 2020 to hit 3.8% on a year-on-year basis. (Chart 4).(i) Domestically, much of the negative impacts associated to Covid-19 to subside by end-April, and policymakers to launch additional waves of counter-cyclical fiscal and monetary policies in the second quarter;
(ii) Outside of China, the global Covid-19 pandemic will be reasonably contained by end of the second quarter and recovery of global growth will resume again in the third quarter of this year
While this will come up short of the 5.5% target growth by 2020 set by the Chinese government's "the Thirteenth Five-Year Plan", we think that a 3.8% growth rate, amid the sudden emergence of a global health crisis, is still rather impressive.
Chart 4: We expect a V-shaped recovery in China's economy across 2020
Table 1: Our 2020 full year estimate for China's GDP growth ranges from 2.0% to 5.9%
|
Case |
Base Case |
Optimistic Case |
Pessimistic Case |
|||
|
Year |
GDP |
Growth Rate |
GDP |
Growth Rate |
GDP |
Growth Rate |
|
2020 Q1 |
19,121 |
-3.0% |
19,318 |
-2.0% |
18,727 |
-5.0% |
|
2020 Q2 |
22,733 |
4.0% |
23,170 |
6.0% |
22,514 |
3.0% |
|
2020 Q3 |
24,157 |
6.0% |
24,613 |
8.0% |
23,702 |
4.0% |
|
2020 Q4 |
26,540 |
7.0% |
27,284 |
10.0% |
26,044 |
5.0% |
|
FY 2020 |
92,551 |
3.8% |
94,385 |
5.9% |
90,987 |
2.0% |
|
Source: Wind, iFAST estiamtes. Data as at 23 March 2020. |
||||||
Domestic consumption slated to surge significantly ahead
While weakness in domestic consumption has shored in the first quarter due to Covid-19, we believe the pent-up demand associated to 'social distancing' measure will be quickly returns once the virus is contained.
Using the 2003 SARS as a reference, the year-on-year growth of the total retail sales of consumer goods in in April and May 2003 declined sharply, but we saw a “retaliatory rebound” in June when the disease was under control.
The year-on-year growth sharply rose to a pre-pandemic level and even created a small peak during the National Day holidays. The total retail sales of consumer goods throughout the year were not significantly affected by the pandemic, and the annual growth rate still reached 9.01%, 0.2% higher than the previous year.
This coronavirus will also present a similar impact on China's domestic demands. Although China’s consumption was almost at a standstill from January to March with the total retail sales of consumer goods in February hit a year-on-year low of -20.5%, the impact of the pandemic on China’s domestic demand growth was short-lived and can be repaired.
Since the beginning of mid-late March, excessive prevention measures have been gradually lifted in various places to encourage residents to resume normal work and life, in addition to tourism-related industries that are still in the slow resumption phrase. In some regions where consumer industries such as catering, retail, and entertainment that are slowly resuming, Ministry of Commerce is urging and guiding the businesses and circulation enterprises to recover in an efficient and organized way, so as to open market as soon as possible and accelerate the recovery of market operation to a normal level.
As of 16 March, the rate of resumption of work for domestic service enterprises has exceeded 60%. When the pandemic prevention and control work is close to an end, China’s domestic consumption will welcome a strong rally, especially in the coming International Workers' Day holidays in May where “small peaks” may come. The rebounding domestic demand is helpful to resist the hit from uncertainties in external markets.
Chart 4: We expect a V-shaped recovery in retail consumption given the pent-up demand
Accomodative monetary policies and fiscal policies to offset the economical damage caused by Covid-19
In terms of industrial production, China’s industrial added value did not decline significantly during the SARS period. It only dropped slightly in April and May, but still maintained high growth rates of 14.9% and 13.7%, and quickly returned to pre-pandemic levels in June.
However, it's worth noting that China did not enforced a complete stoppage of work and production during the SARS period, unlike what they have done recent to curb the spread of Covid-19. Therefore, we think the negative impact of Covid-19 on industrial production will be more significant than that of SARS.
Due to the contagious nature of Covid-19, China has taken measures to fully suspend work and production to avoid group transmission during the resumption of work rush after holidays. Therefore, China paid a heavy price to the suspension with year-on-year industrial added value lost sharply to -25.87%.
Historically, the rapid decline in the year-on-year growth rate of China's industrial added value only occurred during the 2008 financial crisis with a decrease of 20.73%. In the same year, the central government issued a "4 trillion" plan to expand domestic demand and promote economic growth. One year later, China's industrial added value rebounded sharply year-on-year, reaching a maximum of 29.20%.
Chart 5: The Y-o-Y Growth of Value-Added of Industrial Enterprises Above Designated Size
Although this round of coronavirus pandemic caused China’s economy to shut down in the first quarter, the central government has been accelerating the approval of special bonds and the implementation of major projects.
As of 20 March, the Ministry of Finance has issued 1.848 trillion yuan of new local government bonds in 2020, including 1.290 trillion yuan special bonds in infrastructure. At present, local governments have issued more than 70% of the bonds, and the resumption rate of 533 major transportation projects has reached 97.8%.
At the same time, the People's Bank of China released nearly one trillion funds to support enterprises to resume work and production, aiming to conquer a hard time through various measures such as lowering open market operating interest rates, LPR and RRR.
According to the National Development and Reform Commission, as at 20 March, except for Hubei, the resumption rate of key projects across the country has reached 89.1%, and the southern region has reached 98.1%. Among them, Zhejiang, Jiangsu, and Shanghai have approached 100%. Therefore, the industrial added value will gradually recover in the process of resuming work and production in the country, and it will rebound significantly in the second and the third quarter.
China’s economy is more resilient than the US’ economy
Chart 6: As US enters the late stage of its expansion, its companies are becoming more heavily levered.
China A and H markets have great growth potential
On a macro level, we expect China's real GDP growth rate (after deducting the short-term impact of the pandemic for about two quarters) to remain at about 5% in the next few years, while the nominal GDP growth rate is expected to remain at an average annual rate of about 7%.
As a result, we think that the overall earnings of A-share listed companies will increase by 3.0% and 16.0% in 2020 and 2021 (considering the neutral assumption under the impact of the global pandemic). The overall earnings of H-share listed companies are expected to be 1.61% and 11.34% growth in 2020 and 2021.
As to valuation, the P/E of CSI 300 index and HSML100 index are now only 10.5x and 7.85x (as at the close on 24 March), which are far lower than their reasonable P/E of 13x and 12x respectively. Considering the earnings growth and valuation expansion over the next two years, we expect China A-shares and H-shares are about to achieve as high as 50% and 70% potential growth respectively over the coming two years.
At this juncture, we see U.S and Europe still grappling with a worsening Covid-19 crisis in their region, while other Asian markets like Hong Kong, Singapore and Taiwan etc. are facing the second wave of outbreak. More positively, however, we believe China have managed to successfully rein in the spread of the Covid-19 under reasonable control.
Table 2: Upside potentials of China A and H markets are +50% and +70% respectively by end-2022.
Market | Index | 2020E EPS Growth | 2021E EPS Growth | Current Forward P/E | 2020E Forward P/E | 2021E Forward P/E | Reasonable P/E | Potential Growth (to 2021 end） |
China A | CSI 300 | 3.0% | 16.0% | 10.5 | 10.2 | 8.8 | 13 | 50% |
China H | HSML100 | 1.61% | 11.34% | 7.85 | 7.73 | 6.94 | 12 | 70% |
Source: Bloomberg Finance L.P., Wind, iFAST estimates. Data as at 24 March 2020 | ||||||||
China is the market we believe will lead in economic and market recovery this year
Looking ahead, we are starting to see promising signs of improvement in China's economic data. We now China to be the first economy to stage a healthy rebound in growth, given that:
Collectively, we think that growth in the next three quarters will more than make up the weakness in 1Q due to the Covid-19 crisis.(i) Covid-19 situation controlled and its business activities quickly returning to normalcy,
(ii) Policymakers remain supportive via the series of accommodative monetary and fiscal policies,
(iii) sharp rebound in domestic consumption as consumers go on a 'revenge spending' after the period of quarantine.
While the China A/H shares equity markets have been sluggish in recent years, dragged by a plethora of idiosyncratic and external risks factors, like domestic deleveraging and US-China trade war, we see a glimmer of hope that the economy is on a cusp of a recovery.
As the economy starts to recover, we expect both A and H shares can deliver a stellar performance to investors over the next two years.
Chart 7: Earnings Trend of A-Shares (CSI300 Index)
Chart 8: Earnings Trend of H-Shares (Hang Seng China (Hong Kong-Listed Index)
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