Economy | Equities

Navigating A New Uncertainty

_{Posted on Feb 3, 2020}

At the start of 2020, markets have something new to worry about. The virus originating from the Chinese city of Wuhan continues to spread and is a new strain of coronavirus belonging to the same family as the one that caused the SARS (Severe Acute Respiratory Syndrome) crisis in 2003. Headline risk is likely to continue in coming weeks and may continue to pressure regional equity markets as first quarter economic activity in China weakens.

As we write, the majority of cases remain in China, as such quarantine and travel restrictions may be likely in arresting the spread of the virus, Yet, the actions needed to arrest the spread have ground economic activity in the Chinese province of Hubei to a halt, apart from essential activities. There is likely to be an acute contraction in service industries such as tourism across China, and likely Hong Kong and Macau.

During the SARS crisis in 2003, Hong Kong’s equity markets declined 18%, led by the real estate sector, before rising 48% in the following year. China’s then-smaller economy was growing at a faster trend pace of 8% in 2002-2003, and when severe actions to curtain contagion were implemented in 2Q 2003, China’s GDP growth sank to roughly 3% before subsequently jumping to a near-16% pace as activity spanned back.

As China’s economy looks to slow down in 1Q20, Citi analysts expect more decisive stimulus from Chinese policymakers. Over 30 measures have been announced to maintain financial market stability, with the first being the PBoC’s reduction of repurchase rates by 10bps as it injected around RMB 1.2tn of gross liquidity via reverse repurchase agreements. Other potential measures include a cut to the Reserve Requirement Ratio (RRR), tax exemptions to hardest hit sectors and higher local government special bond quotas. Citi analysts see monetary and fiscal stimulus as necessary in mitigating the economic shock and maintain social stability. Assuming a similar economic impact as SARS (1-2% of the economy), China’s GDP for 1Q20 may slow to 4.8% YoY.

With a backdrop of greater volatility, more modest returns in equities are expected than the past five months. Citi analysts expect 4-6% returns for the US equity market in the coming twelve months, and 6-8% outside the US; these amid typical, wide trading ranges. A higher quality strategy is preferred, particularly firms that are able to grow dividends, given their out-performance over the long-term and when markets face short-term challenges.