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Is this the ideal opportunity to buy China equities?

Investors with a long-term horizon and who are prepared to take on a little more risk should consider picking up some undervalued Chinese stocks

ALMOST two months on from the outbreak of Covid-19 in Wuhan, the world's attention remains firmly fixed on the devastating human and economic consequences of the virus and the impact it may have on global markets.

Economic commentators have speculated widely on the potential impact, with some predicting only a temporary dip in equity markets and others forecasting a black swan event that may strangle markets and the global economy throughout 2020. As such, there is a distinct undersupply of certainty for investors attempting to grapple with their investment choices and considering increasing their exposure to Chinese equities.

What we do know for certain is that the immediate economic impact is inherently unknown, and the fear of the unknown has been gripping equity markets in China and across the world. When markets opened after the extended Lunar New Year holiday, the CSI 300 index fell 9.1 per cent. This was its worst opening in nearly 13 years. Investors are struggling to assess the extent of the economic damage caused by the contraction in demand and disruption to global supply chains.

Uncertainty is expected to weigh further on equity prices, particularly in sectors most exposed to the Chinese customer, such as luxury goods, aviation and energy. The chief executive of Alibaba, which sells two-thirds of everything bought online in China, has said that the virus will bring the country to a "standstill" in the coming months.

For an investor with a long-term horizon, though, this may be the ideal time to seek out buying opportunities and increase exposure to Chinese equities.

Manias, panics, crashes and epidemics are an all too frequent feature of financial markets, but follow a similar pattern of short-term disruption followed by long-term recovery. There is little evidence that this time will be any different.

There have been nine major disease outbreaks since 1998. Although all caused short-term economic disruption, the impact on long-term investment fundamentals was limited and economic growth subsequently resumed.

Of course, the past is no accurate predictor of the future. But history suggests that investors should focus on long-term fundamentals when making investment judgements after an epidemic outbreak.

The economic picture in China was largely positive in the latter stages of 2019. On the demand side, value-added tax cuts and payroll tax reductions drove positive effects on consumer spending, keeping retail sales in high single-digit growth year over year into the fourth quarter. On the supply side, the Caixin China General Manufacturing PMI signalled continued expansion towards a three-year high.

In the longer-term, we expect sustainable growth in corporate earnings, particularly among companies that benefit from an increase in domestic sourcing of key value-added components.

Easing trade tensions

There were also promising signs of a de-escalation in trade tensions between the US and China before the outbreak of the virus, and it is likely that this will continue into 2020. China announced a US$75 billion reduction in tariffs on imported goods from the US, on top of the recently signed phase one trade deal, and Chinese officials have every incentive to de-escalate trade tensions and support their export markets.

In the US, there are rumblings that the trade war is damaging exporters in the majority of US states, including President Donald Trump's stronghold states of Texas and Alabama. This may prove crucial going into the US election at the end of the year.

In terms of monetary policy, the People's Bank of China (PBOC) has been quick to react and respond to the crisis in the hope of steering China's economy back to its long-term growth path. In late January, the PBOC announced it would provide US$71 billion of banking liquidity through reverse purchase agreements in order to push down interbank lending rates and provide an economic stimulus. Interest rates on medium term lending facilities to financial institutions have also been cut to provide fresh stimulus directly into the economy.

Once the immediate threat to human life is contained, by controlling the spread of the virus or by finding a cure, we expect positive corporate earnings to continue and the structural growth in China's economy to be sustained.

China has achieved astronomical GDP growth rates in the past 30 years, averaging 6 per cent year on year. Covid-19 will reduce the level of growth to around 4.5 per cent this year, but this is still one of the fastest growth rates anywhere in the world.

Investors who have a long-term horizon and are prepared to take on a little more risk should consider exploiting the current market volatility to purchase undervalued Chinese equities. China remains one of the fastest growing economies in the world with the largest population, and its long-term growth prospects remain intact.

  • Shreemati Varadarajan is head of investments at AAM Advisory, part of Quilter.