As the Greater China region begins to show nascent signs of success in stemming the coronavirus, regional markets have held up better than developed-world markets. With the US and Europe still in panic over the pandemic, we think investors should look at the Chinese experience for guidance.
After three months of battling the coronavirus, it looks like China has started to turn the tide. By mid-March, the number of new COVID-19 cases at the Wuhan epicenter had fallen dramatically. Hong Kong, Taiwan, Singapore and South Korea also appear to be holding up relatively well. In contrast, new cases are rising rapidly in the developed world, where the situation is changing rapidly. Italy is on lockdown and other European countries and the US just starting to impose tougher measures to slow the spread of the virus.
Chinese Stocks Stabilized as US and European Markets Crashed
Market patterns reflected this divergence. While the US market was in free fall last week, Chinese stocks have stabilized. In fact, the MSCI China A Index advanced by 0.3% in US-dollar terms from March 1 through March 12. Over the same period, the MSCI World Index tumbled by 17% and the S&P 500 Index crashed into bear market territory, with a 16% drop.
So why haven’t the Chinese markets fallen more? We think much can be explained by the experience and relative preparedness of the local population for this type of crisis. And, as investors, we’ve also seen markets bounce back quickly from public health crises in the past.
The SARS Playbook—for People and Investors
Back in 2003, southern China, Hong Kong and Taiwan were hit hard by the SARS virus. That epidemic left a lasting and scarring legacy. For example, most office buildings and malls now have hand sanitizers built into the walls. So when the new coronavirus epidemic hit, people knew the drill: face masks and furious handwashing. Concerts were cancelled, and people stayed home and away from restaurants. Many companies—including our firm—quickly shifted into work-from-home mode. These social-distancing and hygiene practices, seared into the population’s mind from 2003, have been largely responsible for containing the virus—beyond anything the government has done.
Equity markets also learned lessons from 2003. Investors quickly dusted off the playbook from the SARS epidemic. They took comfort as government responded with large liquidity injections and promises of stimulus, watched for signs that the epidemic had peaked and quickly re-entered the market. This lack of panic and a “we’ve seen this before” attitude is the main difference between China’s market experience and what’s happening in developed markets today, in our view.
Of course, valuation plays a part, too. In the decade after the financial crisis through the end of 2019, the US market surged and the S&P 500 delivered a cumulative total return of more than 250%. The MSCI China A Onshore Index rose by only 14% over the same period. As a result, the valuation of Chinese stocks simply was not anywhere near their US counterparts when the coronavirus crisis hit. The price/forward earnings ratio of the MSCI China A Onshore was 12.6x at the end of February, while the S&P 500 traded at 21.7x.
Will Developed Markets Follow China’s Path?
With US and European stocks battered this week, many investors are trying to understand whether developed countries will follow China’s path in the fight to stop or slow the virus. Right now, the US and Europe appear to be about four to six weeks behind China’s experience.
You can’t draw direct comparisons because there are big differences. China’s top-down political system allowed it to shut down entire regions to stop the spread of virus. Similar measures are tougher for Western democracies. But social distancing is already starting to take place—including the suspension of public gatherings, the shutdown of the NBA season and school closures.
Panic Selling Reflects Real Uncertainty….
All of this is new to the developed world. And that explains some of the investor panic. To be sure, there will be real economic damage and companies will be hit. Indiscriminate panic selling reflects real uncertainty about the economic fallout, the scale of fiscal stimulus and the impact on earnings across sectors, industries and companies. The world hasn’t faced a global pandemic threat of this gravity for a century. US and European investors feel they don’t have a playbook to cope with this unprecedented situation.
…but China’s Experience Offers Hope
But in fact, we believe that the experience of the Greater China markets in January and February is the best playbook for the US and Europe. The main lesson? Even scary, severe epidemics are usually temporary. And the same is true for stock market crashes induced by a virus, even if the speed of any recovery is uncertain—particularly in the US where valuations were stretched before the crisis.
As in China in January, the coronavirus appears to be spreading unchecked around the world and the market outlook is bleak. Forecasts of potential infections and deaths are staggering and tragic. We do not underestimate the dangers.
Yet similar forecasts were made about China two months ago. There are still fears of a “second wave” of infections and many people question the accuracy of the Chinese data. However, we think the improving situations in Taiwan, Singapore and Hong Kong—where the data is widely considered more robust—offer tangible evidence that the crisis is getting under control in the region.
Just like in China today, we’re hopeful that more aggressive government steps and social-distancing measures can help developed countries fight the virus. Warmer spring weather may help, too. For now, the uncertainty is real and market volatility will persist until signs of improvement are seen. But if the US and Europe take the right steps and successfully see infection rates plateau, we believe that the world could ultimately follow the Chinese markets’ road to recovery.
