SINGAPORE (May 15): The dynamics of globalisation were already changing before Covid-19. That shift has been accelerated by the Covid-19 shock testing supply chains in healthcare and pharmaceuticals, food supply chains and technology infrastructure, prompting governments to increasingly treat these sectors in the same category as national security. Rather than sourcing from competitive suppliers, countries will aim to be more self-reliant. “They will also be subjected to increased regulation and oversight, giving them characteristics closer to the utility or defence industries,” says Fidelity International.
“While more regulation could lead to lower profits over time, it is also likely to create more stable earnings and cash flows, potentially benefiting valuations. These sectors should prove to be winners, but due to less physical travel between and within countries, travel and leisure, lodging, transport and cross-border education could be impaired,” the asset manager adds.
Broadly, technology and innovation will be relative winners in the long term. Online banking, e-commerce, streaming, and online gaming and gambling companies will all see growing adoption. “While there will be some reversal to bricks and mortar after the lockdown, we are seeing a clear acceleration in online adoption and believe such shifts will be permanent,” says Nicholas Grace, equity portfolio manager at Capital Group, without naming specific stocks.
He warns of growing regulatory intervention on companies. “Previously, we have seen significant intervention in the banking sector in terms of Tier-1 capital levels, CEO compensation, as well as dividend and buy back distributions. This trend is expected to spread across other industries and affect a swathe of companies. Industries that have taken assistance from governments will be especially subjected to regulatory scrutiny,” says Grace.
Amid the tensions, US bank Morgan Stanley remains upbeat on certain Chinese stocks. “We acknowledge the rising risk but believe it is not currently enough to derail China’s outperformance versus the broader emerging markets.” The bank’s economists believe that the overall macroeconomic direction will not be materially impacted as additional tariffs are less likely to be implemented. “Therefore, China’s recovery trajectory as the ‘first in, first out’ from the Covid-19 pandemic is intact, warranting better visibility and certainty for corporate earnings,” says Morgan Stanley.
Among Chinese stocks, Morgan Stanley favours those in ecommerce and online entertainment — which besides the growth prospects, are those better positioned in this new “social-distancing resilient” online economy.
Furthermore, Morgan Stanley’s preference is for A-shares and not the basket of ADRs, for a couple of key reasons. First, the trading currency is in RMB, instead of USD for the ADRs. This makes the A-shares less susceptible to fluctuations between USD and RMB. Next, the proportion of non-Chinese ownership of A-shares is generally lower, which implies lower redemption risk if things worsen.
Morgan Stanley’s top 10 A-share picks (see table) come from various different sectors ranging from IT to consumer and healthcare. The 10 stocks share a few common themes. They are well-poised to enjoy exposure to long-term secular growth themes such as so-called New Infrastructure, consumption upgrade, tech localisation, and reform of state-owned enterprises. These picks are also industry leaders with robust financials and best positioned to gain market share during down cycles.
Even so, Grace of Capital Group reminds investors that over a long period of time, there is very little correlation between economic growth and stock market returns. For example, China has grown four times faster than the US in terms of GDP over the last quarter of a century. Yet, equity returns from China and the US have been almost identical. “It is important that we look at growth at a company level alongside industry structure, and how that may or may not change over time,” he says.
“It is important to ask what the world will look like in five, six or seven years and what companies will benefit from that. If you are looking for valuations in year one or year two and not studying long-term insights, you will miss key opportunities. It is important to ignore short term noise in order to navigate through these tough and unprecedented times,” adds Grace.
