Marta Klos
By Wei Siong Cheong, CFA
China’s emergence from COVID lockdowns could trigger a cyclical upswing, benefiting real estate and convertible bonds.
China is rapidly unwinding its “zero covid policy.” While this has led to an unprecedented rise in infections, we might already be past the peak of the current COVID wave. High-frequency mobility data has started to show a significant rebound from December lows, especially in higher-tier cities. The government estimates that passenger turnover could reach 80% or more of pre-pandemic levels during the upcoming Lunar New Year travel season. In our view, a faster-than-expected reopening, coupled with easier property sector policies and tech sector regulations, is likely to tilt the economy toward a strong and early cyclical recovery this year.
Pent-up demand, supported by high excess savings, will likely drive a major surge in consumption during the initial recovery period. Sectors benefitting from this recovery could include transportation (e.g., airlines), retail (e.g., restaurants), outbound tourism (e.g., Macau gaming and Hong Kong retailers), consumer discretionary (e.g., apparels) and healthcare (e.g., medical services). Meanwhile, fiscal and monetary policies should remain largely growth supportive, especially in the absence of any meaningful inflationary pressures.
We believe there will be broad-based ramifications for the financial markets. Valuations on China equities are attractive, and the asset class should see strong momentum in the first half of the year. In fixed income, we are especially enthusiastic about the prospects of convertible and property sector bonds. Convertible bonds participate in equity upside with limited downside risks. On the property front, a significant portion of China’s high yield property bond universe is trading at distressed levels. The recent emphasis on improving the balance sheets and financing capability of “systemically important” developers reflects regulators’ intention to support the sector and “ringfence” better names. Homebuyer sentiment will also likely improve amid economic recovery, reviving contracted sales. We believe these factors have not been fully priced in by investors and that the sector should provide a source of potential upside in the months ahead. In contrast, we are less optimistic on the outlook for duration. In our view, stronger growth and increased supply pressure should keep rates grinding higher for most of 2023.
Such a backdrop, with a stronger credit market but higher rates outlook, may be incorporated into a total return strategy, allowing investors to potentially benefit from appreciation potential tied to credit-quality improvements, while higher core yields should provide a better carry environment.
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