What’s next after the sell-off? Hong Kong and China equities update

23 March, 2020

Kai Kong Chay, Greater China Specialist

The ongoing coronavirus (COVID-19) outbreak, coupled with recent oil-price volatility, have placed pressure on Hong Kong and China equities. In this investment note, Kai Kong Chay, Greater China Specialist, provides an update on the asset class and explains why he thinks that corporates will weather the uncertain backdrop and still deliver positive earnings growth in 2020.

Despite the coronavirus outbreak and the oil-price slump, offshore Hong Kong and China equities have been resilient, with the MSCI China Index outperforming the MSCI World Index by over 12 percentage points. Furthermore, the Shenzhen Stock Exchange Composite Index is one of the world’s most resilient indices this year¹ . In this investment note, we will share our views on some of the investment themes that have been affected by the recent uncertainty, such as consumption, and provide an update on our secular long-term themes.

Earnings outlook

In an early effort to contain the virus, the Chinese government extended the Lunar New Year holiday, introduced quarantine measures and imposed traffic restrictions. As a result, factory production and new orders in the country collapsed to record lows in February² . Therefore, it will not be a surprise if the first-quarter earnings of China’s corporates are negatively affected. It is now mid-March, and we can already see a gradual and orderly resumption of industrial production in 90%³ of the country’s provinces (excluding Hubei). Also, the government’s supportive policies, such as lowering benchmark lending rates, suspending corporates’ social security payments, and the potential for further fiscal stimulus with new infrastructure projects, mean that the impact of COVID-19 on China’s economy should be relatively limited this year.

As the COVID-19 outbreak has now extended globally, earnings forecasts for Chinese equities have declined to 8%.⁴ Nevertheless, investors shall continue to see investment opportunities in companies that have the potential to deliver solid earnings growth over the next two-to-three years.

Consumption services in, travel names out

Seasoned investors have taken the sell-off opportunities to reinforce high conviction ideas and avoid names with more downside risks. Considering the global outbreak of COVID-19, investors should fine-tune their focus within consumption sector— cautious in travel and tourism related names and positive on domestic-driven consumption services. We believe there may be more negative surprises from travel-related sectors in the first quarter and the first half of this year, as restrictions on movement are now being extended globally and are should remain in place for the next few months.

The recent commodity-market tumble has fanned the flames of an already volatile stock market. US Brent crude oil collapsed by as much as 34% on 9 March⁵ , after Saudi Arabia shocked the market by launching a price war against Russia.

Cautious in the energy sector

We believe investors should maintain defensive approach to the energy sector⁶ :

From a tactical perspective, cautious in the upstream energy sector, particularly oil companies.
Avoid petrochemical-related commodities.
Remain selective in some indirect investments in downstream utilities, such as domestic gas distributors, which are expected to be net beneficiaries of the lower gas prices, which, in turn, may boost consumption.

Despite this uncertain backdrop, the key secular trends that form the basis of our three investment themes remain unchanged:

Consumption Upgrade

We believe the current market volatility presents a good buying opportunity to education, property management and other omni-channel driven e-commerce names.

For example, the penetration increase of online education hit the highest by more than one year due to school closures. Leading providers are exhibiting clear competitive advantages by merging offline learning with online. This is due to scale, a timely ramp-up in online content and high execution capabilities.

We believe these structural changes in consumer behaviour will not be reversed when the overall situation normalises.

Property-management service is another area where structural growth should persist. The gross floor area for properties under management in the residential and commercial space is expected to increase by 10.1% and 16.0% respectively⁷ . This will translate into robust demand for quality property services, and we believe that top-tier property managers with good execution capabilities will gain market share in the medium term.
Research and Development (R&D)

On the healthcare side, there has been talk of an approved COVID-19-related vaccination, but we think that speculative opportunities such as this will be short-lived.

We acknowledge that while governments need to speed up the approval of vaccines and virus-related drugs, the approval of other medications (e.g. cancer drug) may be delayed. Nevertheless, the investment case for healthcare remains solid – the sector is supported by an ageing population and unmet medical needs. Investors should continue to focus on biotech and medical equipment companies, where import substitution, favourable government policies and industry consolidation will allow high-quality winners to surface. Furthermore, investors may consider capturing exposure to outsourced research service providers (Contract Research Organisation, CRO) that do not need to bear binary risks but enjoy the ongoing growth in demand for biotech R&D projects.
Technology

Our interest in companies that will benefit from the rollout of 5G services remains in place, as we believe that 5G eco-systems will be a prominent theme in Chinese equities. Investors should continue to capture this thematic opportunity from multiple fronts, including upstream equipment, semiconductors, downstream handset components, big data analytics, and cloud services. Close attention will also be paid to valuation levels along the entire supply chain, and we will look to rotate into quality holdings, such as handset components, that have corrected in the broad-based market sell-off.

A focus on longer-term themes

The COVID-19 outbreak is undoubtedly causing a great deal of uncertainty among investors that is translating into heightened market volatility. However, by remaining calm and looking through the near-term disruption, we can see that current events may not necessarily act as a drag on China’s economic and earnings growth. As such, investors should focus on the longer-term investment themes that are designed to provide stable and secular growth.

¹ Bloomberg, as of 16 March 2020. Year-to-date index price returns in local currency: MSCI China Index: -15.11%; MSCI World Index: -27.80%; Shenzhen Stock Exchange Composite index: -0.63%.

²Caixin/Markit Manufacturing Purchasing Managers’ Index, February 2020.

³ HKEJ, 17 March 2020

⁴ Bloomberg, 17 March 2020. China equities refer to MSCI China.

⁵ Bloomberg, 10 March 2020.

⁶ Manulife Investment Management, 10 March 2020.

⁷ Estimate compound annual growth rate (CAGR) from 2018 to 2023. CNInsights, China Property Management Association, January 2019.

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The Multi Asset Solutions Team (MAST) provides asset allocation views on three recent developments that could influence markets in different ways: the SpaceX Initial Public Offerings (IPO), the reopening of the Strait of Hormuz, and the Bank of Japan’s (BOJ) rate hike. In our view, these events create mixed signals across growth, inflation and liquidity. Overall, the backdrop still appears uneven, and this may support a measured and selective approach to asset allocation rather than a broad increase in risk.

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Semiconductors sit behind almost every modern experience – from smartphones and cars to cloud computing and today’s AI tools – yet they remain largely invisible to most people. They are more than chips only, and the demand is being supported by several long-term forces. We believe that today’s semiconductor excitement is not a repeat of the dot-com bubble, as investment is tied to real infrastructure and revenue-generating services. And the opportunity is broader than a handful of headline AI names.

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Funds offered on this platform may invest in equity, fixed income securities, exchange-traded funds, collective investment schemes and/or other instruments, including derivatives, and each of which has its specific investment objective/ policy with its specific features and different risk profile.
Distribution of dividends, the frequency of distribution and the amount/rate of dividends are not guaranteed. Dividend of certain share/unit classes, at the fund or the investment manager’s discretion, may be paid out of capital or gross income while charging / paying all or part of its fees and expenses out of its capital. This amounts to a return or withdrawal of part of an investor’s original investment or from any capital gains attributable to that original investment, and may result in an immediate reduction of the net asset value per share/unit of the respective share/unit classes after the distribution date.
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Some funds may invest in emerging economies or markets, where special risks, including liquidity, volatility, government policies, taxation, currency, currency repatriation, political and regulatory risks, may be substantially higher than the risks normally associated with more developed economies or markets.
Some funds may invest in securities of small and/or medium sized companies in the relevant markets. This can involve greater risk than is customarily associated with investments in larger and more established companies.
Some funds may invest in a single country/region and/or a particular industry sector which may be concentrated and subject to greater risks than diversified investments in several countries and/or regions and across sectors.
Some funds may invest directly in certain China A shares via the Stock Connect, which may involve risks related to investments via the Stock Connect and Mainland China investment.
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Some funds with significant exposure to RMB bonds/equity/assets may hold a significant portion of assets in deposits if there are not sufficient RMB instruments to invest in. This may adversely affect the funds’ return and performance.
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Some funds’ performance will be closely tied to the economic, political, regulatory, geopolitical, market, currency or other conditions in the European Economic Area and may be subject to increased liquidity, price, and foreign exchange risk.
Some funds may invest in Russia and some investments in Russian securities may be unlisted securities not dealt on a regulated market. The Russian market presents specific risks in relation to the settlement and safekeeping of securities.
Investment involves risk. Investors may expose to capital loss and should not invest solely based on the information on this website alone and should read the offering documents for details including the associated risk factors, charges and features of the funds and their share/unit classes. Past performance information is not indicative of future performance.

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Manulife Global Fund is an umbrella fund comprising a number of sub-funds investing in equity and/or fixed income securities, each of which has a different investment objective and risk profile and may involve equity market, geographical concentration, sovereign debt, liquidity, volatility, credit downgrade, interest rate, counterparty risks. Certain investors may also be subject to the risk relating to RMB hedged share class.
The relevant distributing class of the sub-funds does not guarantee distribution of dividends, the frequency of distribution and the amount/rate of dividends. Dividends may be paid out of income, realized capital gains and/or out of capital of certain sub-funds in respect of Inc share class(es). Dividends may be paid out of realized capital gains, capital and/or gross income while charging all or part of their fees and expenses to capital (i.e. payment of fees and expenses out of capital) in respect of MDIST (G), R MDIST (G) and F MDIST (G) share class(es). Dividends paid out of capital of these sub-funds amounts to a return or withdrawal of part of the amount of an investor’s original investment or from any capital gains attributable to that original investment and may result in an immediate decrease in the net asset value per share in respect of such class(es) of the sub-funds. Fixed yield share classes pay out a pre-determined annualized fixed percentage of their NAV, which can be adjusted by the Directors with at least one month’s prior notice, do not entirely reflect the actual or expected income or performance of the Fund. These distributions may exceed the actual income, leading to capital erosion, especially during negative returns or losses, and may reduce future capital growth. A positive distribution yield does not guarantee a positive return, and the absolute distributions vary with the NAV, resulting in fluctuating monthly payouts for investors.
Certain sub-funds invest in emerging economies or markets, where special risks, including liquidity, volatility, government policies, taxation, currency, currency repatriation, political and regulatory risks, may be substantially higher than the risks normally associated with more developed economies or markets.
Certain sub-funds invest in securities of small and medium sized companies in the relevant markets. This can involve greater risk than is customarily associated with investments in larger and more established companies.
Certain sub-funds concentrate their investments in a single country and/or a particular industry sector are subject to greater risks than diversified investments in several countries and/or regions and across sectors.
Certain sub-funds may invest directly in certain China A shares via Stock Connect, which may involve in risk related to Investments via Stock Connect and Mainland China investment.
Investment involves risk. The sub-funds may expose their investors to capital loss. Investors should not invest solely based on this material and should read the offering document for details including the risk factors, charges and features of the sub-funds and their share classes.
Each sub-fund intends to use financial derivative instruments (“FDIs”) for investment, efficient portfolio management and/or hedging purposes. The use of FDIs exposes the Fund to additional risks, including counterparty/credit risk, liquidity risk, valuation risk, volatility risk and over-the-counter transaction risk.
Given RMB is currently not a freely convertible currency, payment of redemptions and/or dividend payment in RMB may be delayed due to the exchange controls and restrictions applicable to RMB. As offshore RMB (CNH) will be used for the valuation of RMB denominated Class(es), CNH rate may be at a premium or discount to the exchange rate for onshore RMB (CNY) and there may be significant bid and offer spreads and thus the value of the RMB denominated Class(es) will be subject to fluctuation. Any devaluation of RMB could adversely affect the value of investors’ investments in the RMB denominated Class(es) of certain sub-funds.

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Certain sub-funds with significant exposure to Renminbi (“RMB”) bonds/equity/assets or emerging markets, may involve debt instrument, credit/counterparty, concentration, liquidity, volatility, currency, tax, economic, foreign exchange/multi-currency conversion, down-grading, regulatory and political risks and these risks could be substantially higher than the risks normally associated with the world's more established markets.
A bond sub-fund may hold a significant portion of assets in deposits if there are not sufficient RMB instruments for it to invest in. This may adversely affect its return and performance.
Certain sub-funds using invest directly in debt instruments/shares via QFII regime, the Bond Connect and/or the Foreign Access Regime are subject to various requirements and restrictions under the laws of Mainland China related to investment in QFII and/or China Interbank Bond Market and custodial risks.
RMB is not freely convertible and is subject to exchange controls and restrictions.
Certain sub-funds may have significant concentrated exposures to particular industry sectors and geography's, which subjects investors to concentration and equity market risk.
Certain sub-funds may invest in equities of small- and mid-capitalization companies, which can expose investors to liquidity and volatility risks, and is subject to greater risk than is customarily associated with investments in larger capitalization companies.
Investment involves risk. The sub-funds may expose to a high risk of capital loss. Investors should not invest solely based on this material and should read the offering document for details including the risk factors, charges and features of the sub-funds.

Manulife Hong Kong Series

Manulife Hong Kong Series (“the Series”) is an open-ended unit trust comprising a number of funds primarily investing in equities, debt securities, exchange-traded funds and/or collective investment schemes, each of which has a different investment objective and risk level.
The funds do not guarantee distribution of dividends, the frequency of distribution, and the amount/rate of dividends. Dividends may be paid out of capital and/or out of gross income of certain funds in respect of Inc classes, while charging/paying all or part of certain funds’ fees and expenses to/out of capital of certain funds. This represents a return or a withdrawal of part of an investor's original investment amount or capital gain attributable to that amount. Distributions will result in an immediate decrease in the net asset value of the relevant units. Class AA (RMB) Inc Hedged Unit of certain funds is subject to higher distribution risks than other non-hedged unit classes.
Certain funds may involve equity market, emerging markets, Dim Sum bond market, concentration, volatility, liquidity, credit, credit ratings, below investment grade and unrated securities, credit rating downgrading, interest rates, valuation, sovereign debt, unlisted debt securities, political and regulatory, currency, foreign exchange, derivative and structured product, hedging, and distribution risks. Certain investors may also be subject to the risk relating to RMB hedged share class..
Certain funds are subject to the risks of investing in other funds and the risks relating to asset allocation strategy and/or downside risk management process.
Certain fund is subject to the risks relating to investment in exchange traded funds, Strategic and Tactical Asset Rebalancing Strategy (“STARS”), small- and mid-capped companies, convertible bonds and the risks associated with securitised debt instruments and investments in loss-absorption features. Certain fund is a feeder fund that invests all or substantially all of its assets in another collective investment scheme (the “master fund”) and is therefore subject to the risks of investing in the master fund.
Certain fund will not have direct investments other than cash, cash equivalents and financial derivative instruments (such as futures, options and forwards).
Investment involves risk. The funds may expose its investors to capital loss. Investors should not make investment decisions based on this material alone but should read the offering document for details, including the risk factors, charges and features of the Fund and its unit classes.