Summary

With many factories, manufacturing facilities and production lines in China currently up and running after months of hiatus during the lockdown period, the country’s key economic indicators have recently started trending higher, as the world’s second largest economy gradually recovers from the fallout of Covid-19. Will China be the first major economy in the world to rebound from the coronavirus recessionary blues, notwithstanding the threat of a second wave of infections? And which sectors and stocks in China could benefit the most as world’s factory restarts? Read on to find out.

First in, first out

China is the first country in the world to bear the brunt of the devastating Covid-19 outbreak, which started in late December 2019. It is also the first nation to implement strict lockdown measures in many of its virus-hit cities, such as Hubei, in order to curb the spread of the disease, and one of the earliest economies to reopen when the epidemic in the country became manageable.

Will China—often dubbed as the world’s factory—be the first major economy in the world to rebound from the coronavirus recessionary blues, notwithstanding the threat of a second wave of infections? Time will tell. But the prospects do look promising, judging from some of China’s recently released economic data.

To recap, China lifted its lockdown measures on most cities in March 2020 after reporting zero new local Covid-19 infections for five consecutive days. In early April, the Chinese government ended the months-long lockdown in Wuhan—the city where the Covid-19 outbreak first began and where 11 million people had been under a strict lockdown since 23 January 2020. With many factories, manufacturing facilities and production lines in China currently up and running after months of hiatus during the lockdown period, the country’s key economic indicators have recently started trending higher, as the world’s second largest economy restarts and gradually recovers from the fallout of Covid-19.

China’s industrial production, for example, grew by 4.4% on a year-on-year (YoY) basis in May, boosted by a pickup in equipment manufacturing and high-tech manufacturing, according to National Bureau of Statistics of China. That’s 0.5% higher than April’s industrial production growth of 3.9% YoY and a vast improvement as compared to the negative numbers in the first three months of the year. China’s industrial production was down 1.1% in March from a year earlier, after plunging 13.5% YoY in both February and January, when the Covid-19 outbreak was at its worst in the country (see Chart 1).

Chart 1: China’s Monthly Industrial Production (% YoY)
Chart 1: China’s Monthly Industrial Production (% YoY)

Source: National Bureau of Statistics of China

In addition, the country’s Index of Services Production turned positive in May, registering growth of 1% YoY, which is significantly higher than the 4.5% contraction in April. Areas such as information transmission, software and information technology services lifted China’s services production in May, according to the National Bureau of Statistics of China.

Elsewhere, the Caixin China General Manufacturing Purchasing Managers’ Index (PMI) entered positive territory in May, rising to 50.7 from 49.4 in April. (A PMI reading above 50 represents an expansion when compared with the previous month, while a reading below 50 represents a contraction). China’s May PMI was the highest since January 2020, as new orders and manufacturing-related buying increased with the restart of the Chinese economy.

Increased activities in the manufacturing hubs of China can be ascertained to some extent by the level of air quality in those areas. China’s pollutant index—an unofficial gauge of industrial activities—has been gradually rising (see Chart 2) after the 9-10th week of the Lunar New Year (LNY), when the nation extended the holiday period as part of its lockdown measures. Reaching pre-LNY levels, the index does give empirical evidence of the reopening of factories in China, concurring with latest official data that shows a resumption of economic activities in the country.

Chart 2: China manufacturing hubs’ pollutant index
Chart 2: China manufacturing hubs’ pollutant index

Source: CREA

Data to keep an eye on

With a recent pickup in economic and business activities in China, economists are currently looking closely at the nation’s retail sales, export numbers and fixed asset investment (all of which were still in the red in May) to gauge if the nascent recovery in the world’s second largest economy is sustainable.

Retail sales of consumer goods in the country, which include spending by households, governments and businesses, continued to fall in May, declining 2.8% YoY. The May numbers, however, marked an improvement from April’s decline of 4.7%. Chinese exports in May also shrank 3.3% YoY due to weak demand from the rest of the world, while fixed-asset investment declined at a slower pace in May as compared to the previous month.

Fixed-asset investment, a key driver of domestic demand that includes government-led infrastructure spending, declined 6.3% YoY in the first five months of the year. The rate of decline slowed from the 10.3% drop from January to April, a 16.1% slump in 1Q 2020, and a record 24.5% fall in January to February, according to National Bureau of Statistics of China, which only releases cumulative figures for investment.

In 1Q 2020, China’s GDP shrank 6.8% YoY, marking the first GDP decline since the nation began reporting quarterly data in 1992 (see Chart 3). After stalling in the first quarter, China’s economy is likely to be revived in 2Q and the 2H of the year, as long as the new infection clusters in Beijing—vicinity near Xinfadi, the capital’s largest seafood and vegetable market—are under control and the fresh Covid-19 outbreak doesn’t spread to the rest of the other Chinese cities.

Chart 3: China’s GDP growth rates (% YoY)
Chart 3: China’s GDP growth rates (% YoY)

Source: National Bureau of Statistics of China

Risk of a second wave of Covid-19 infections

To be sure, should the latest virus outbreak in Beijing escalate into a full-brown second wave of Covid-19 infections in China that requires a second round of large-scale lockdowns in virus-hit cities, then all bets are off for a sustainable rebound in the world’s second largest economy.

So far (as at end-June 2020), the situation seemed to be under control. Indeed, after new Covid-19 cases were detected in Beijing in mid-June, tracing back to Xinfadi, the Chinese authorities immediately took action to contain the outbreak. These measures included shutting down the contaminated seafood and vegetable market; the closure all schools in the capital; a lockdown on several residential compounds with confirmed cases; and mass Covid-19 testing of residents near the infection cluster. Furthermore, citizens who had contact with infected individuals from the new clusters were not allowed to leave the Chinese capital and some transportation routes from Beijing to other cities and provinces had also been ceased.

It remains to be seen if Beijing’s new infection clusters will derail the economic recovery of China. Without a doubt, slower economic growth this year is a certainty for China, whose central government recently dropped its annual economic growth forecast for the year, citing great uncertainty posed by the Covid-19 pandemic. All eyes will be on China as to whether its economy can bounce back in 2021, given the threat of a second wave of Covid-19 infections as well as other economic challenges, such as higher level of bankruptcies, a rise in unemployment levels, escalation of US-China tensions and the diminishing reliance of China’s supply chain from its trading partners.

Longer-term investment outlook

Although there is no GDP growth target for China this year, we believe policy supports are still strong enough to enable the Chinese economy to generate positive growth for the whole of 2020. After all, China’s economy is growing at a pace that is much faster than that of the global economy.

To reiterate, economic indicators are showing that China’s economy is recovering steadily on the back of work resumption and improving domestic consumption. At the same time, liquidity conditions continue to be accommodative during the economy recovery phase. In our view, the Chinese government will try its best to stabilise the employment level in China by stimulating the economy with loosening monetary policy, while putting up with high fiscal deficits.

Nonetheless, earnings growth for the bulk of Chinese companies in 2020 could continue to disappoint and the recovery in 2021 still looks cloudy for now due to the uncertainties of the Covid-19 pandemic and worsening US-China tensions.

Despite external uncertainties, the fundamentals of China A-shares continue to improve month by month and industries in China driven by domestic demand have recovered well. For now, we will remain focussed on areas of structural opportunities, preferring domestic-oriented sectors and stocks to those related to overseas demand.

Domestic support in China has proceeded with increased municipal debt issuances and targeted fiscal stimulus, particularly in areas of strategic industry development, namely 5G, digital, automation and environmental. We remain focussed in these areas of attractively priced structural growth, as well as others in the software, healthcare, insurance and select consumer sub-sectors.

Over the longer term, Chinese technology stocks, especially in the 5G construction and cloud computing areas that have underperformed of late due to the fears of new US export restrictions, are expected to outperform. The new technology cycle and the rapid pace of digitalisation in the post Covid-19 world should continue benefitting these tech-related stocks.

As the first country to be hit hard by Covid-19, China could also be the first economy to bounce back from the pandemic and may even emerge stronger, given the rise of its high-tech and digital-economy related industries. As the old adage goes, “What doesn’t kill you, makes you stronger”.