- In February 2020, the S&P 500 finished down almost 8% in a month finished by the US market's fastest 6-day, 10% drop since 1933 on news of Covid-19's spread.
- Meanwhile, China's A-share market rose over 8% over the same month, while the more offshore MSCI China index rose 3.3%, bouncing from a January similar to the US market's February.
- An optimist might say this reflects the impacts of coronavirus within China may have peaked, and be echoed ex-China with a roughly one month lag.
- Longer-term, what matters to stock valuations is what the overall impact to corporate earnings will add up to. This will of course hit different sectors differently.
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I usually try and tune out shorter-term noise and returns, but find stock market corrections like the one last week (the fastest since 1933) useful for looking at risk exposures and how information gets reflected in prices.
First of all, let's take a look at some numbers comparing recent price returns of three different benchmarks:
- The world's largest and most liquid ETF tracking the US' S&P 500, the SPDR S&P 500 Trust ETF (SPY), and
- The largest US-listed China ETF, tracking a broad institutional benchmark of mostly US and Hong Kong listed shares: the iShares MSCI China ETF (MCHI), and
- The largest US-listed tracker of China's main onshore benchmark of Shanghai and Shenzhen listed shares, the Xtrackers Harvest CSI 300 China A-shares ETF (ASHR)
For background, you can also refer to my earlier articles about the difference between onshore vs offshore listed Chinese stocks, how to choose China ETFs, and why I avoid funds tracking the S&P 500.
China vs. US Stock Returns Since The Coronavirus Outbreak Started
The below three charts compare the returns of SPY vs. MCHI and ASHR over three different time periods: the past one week, the past one month, and past three months.
In the last week of February 2020, when US markets seemed to first take the risk of the spread of the coronavirus disease Covid-19, SPY fell over 11%, while MCHI and ASHR each fell "only" around 3%. For reference, the map of coronavirus cases I have been checking most often is this one from Johns Hopkins, which shows a chart of cases within vs outside Mainland China in the lower right hand corner.
Over the whole month of February 2020, we see SPY fell almost 8% over the course of the month, while MCHI and ASHR fell 3.3% and 8.1% respectively.
Zooming out to three months, we can see the apparent resilience of the China market over the past month was mostly due to recovering from a much sharper drop the previous month. Already in January, risks of the spread of what is now known as Covid-19 were obvious to those of us living in Asia, with Hong Kong's Education Bureau announcing on January 27th the extension of Chinese New Year holidays to mid-February, and then later on February 25th that school closures would continue until at least April 20th.
China Still More Priced For Disruption Than the US
It is debatable how well the recovery in Chinese stocks reflects policy response versus deeper calculations of how extensive or limited the impact of the virus will be on total corporate earnings. It seems obvious that the virus has ground China's economy to a relative halt for at least a month (especially judging by satellite air pollution levels), but nobody really knows whether it makes sense to zero out 1-2 month's earnings or 1-2 years earnings from the model. If we use a super-rough, no-discounting-necessary model of a stock being roughly worth the rough sum of the next 10-20 year's projected earnings, months should mean a few percentage points' drop, while over a year's earnings lost would justify a 10-20% drop.
If we look at a high level, long term comparison of two of the top companies in each market: Amazon.com Inc (AMZN) in the US vs China's Alibaba Group Holding Ltd (BABA), we see that AMZN has long traded at over double BABA's price to free cash flow ratio, despite BABA regularly posting higher YoY sales growth. This sort of "higher growth at a lower price" example is one reason I have been increasingly recommending significantly higher allocations to emerging markets like China at today's valuations. In this case though, what it tells me is that BABA has already been priced for some challenges, while US names like AMZN have been priced a bit too much for perfection.
The Sector View
While I remain bullish on China, I am not equally bullish on all sectors, and especially not on China's banks. One of the biggest complaints I have had with top China ETFs like MCHI and ASHR is their high allocation to banks and other financials, and I simply do not like owning Chinese bank stocks. Although I acknowledged pressure on state-owned firms to make less money during times of stress for the benefit of the greater good was a risk factor for China Mobile, I believe the downside is far greater for lenders than for mobile networks. My base case assumption for China over the next few years (which needs far more study to support) is that Beijing will pressure its banks to extend maximum support to prevent a hard economic landing, and that bank shareholders (state and private) will bear the costs. The next chart compares how the past three month's "stress test" affected four different sectors within China differently:
- KraneShares MSCI All China Health Care ETF (KURE), and
- KraneShares CSI China Internet ETF (KWEB), and
- Global X MSCI China Consumer Discretionary ETF (CHIQ), versus
- Global X MSCI China Financials ETF (CHIX)
This chart seems to indicate these four sectors moved more or less together in December 2019, then started diverging in January, and by the end of February we see the clear spectrum between China health care and internet sectors outperforming while consumer discretionary and financials underperformed. One simplistic way of reading this is to say that the Chinese economy still needed medicines and hospital equipment and services provided by Baidu, BABA and Tencent, while traditional retail and loan portfolios seem most likely to suffer. While I still have my doubts about the momentum factor or any other short-term indicator, I don't disagree that we are likely to see a continuation of this pattern across China's sector returns in the coming years.
The coronavirus continues to dominate the news as we enter March 2020, and nobody really knows how far it will spread and eventually impact lives and economies globally. The optimist in me tends to believe signs that the spread of the virus within mainland China has largely peaked and been well-contained, and that while smaller outbreaks now seem to be echoing elsewhere, I expect those will be mostly contained about as quickly. Bloomberg reads last month's market reaction as already pricing in a virus-triggered recession, though I believe it is important to remember recessions don't hit all countries and sectors evenly. I continue to favor tilts towards non-financial names that are value priced with high quality earnings and low debt, especially those positioned for China's resumption of growth after this virus. Of the above mentioned names, I am especially continuing to buy China Mobile Limited (CHL) and Baidu Inc (BIDU) on dips like the ones we saw last week.
Stay safe, and remember to wash your hands!
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This article was written by
Tariq Dennison, runs an RIA focused on international clients and portfolios, applying his on-the-ground experience as an expat investing in diverse foreign markets. Tariq is the author of the book "Invest Outside the Box" and soon-to-be-released "10 Ways To Invest." He lives in Switzerland, and has worked in Finland, Canada, the UK, Hong Kong, and Singapore.Tariq is the leader of the investing group The Expat Portfolio where he helps members invest internationally with greater clarity and confidence. Features of the service include: Frequent, short, and focused analysis, access to his watchlist and dashboard, guides to specific foreign markets, and direct access to Tariq and his community in chat for discussion and questions. Learn more.
Analyst’s Disclosure: I am/we are long CHL, BIDU. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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