Martha Klos
By Wei Siong Cheong, CFA
China’s exit from COVID lockdowns could trigger a cyclical rebound benefiting real estate and convertible bonds.
China is rapidly phasing out its ‘zero Covid’ policy. While this has led to an unprecedented surge in infections, we could already have passed the peak of the current COVID wave. High-frequency mobility data has started to show a significant recovery from December lows, particularly in higher-tier cities. The government estimates that passenger turnover during the upcoming Lunar New Year travel season could reach 80% or more of pre-pandemic levels. In our view, a faster-than-expected reopening, combined with easier real estate sector policies and tech sector regulations, is likely to propel the economy towards a strong and early cyclical recovery this year.
The pent-up demand, supported by high levels of excess savings, is likely to result in a sharp increase in consumption during the initial recovery phase. Sectors that could benefit from this recovery could include transportation (e.g. airlines), retail (e.g. restaurants), outbound tourism (e.g. gaming in Macau and retailers in Hong Kong), consumer discretionary (e.g. clothing) and healthcare (e.g. medical services). Meanwhile, fiscal and monetary policies should remain broadly pro-growth, especially in the absence of significant inflationary pressures.
We believe there will be far-reaching implications for financial markets. Chinese equity valuations are attractive and the asset class should see strong momentum in the first half of the year. Within Fixed Income, we are particularly excited about the prospects for convertibles and real estate bonds. Convertible bonds participate in equity upside with limited downside risk. On the real estate front, a significant portion of the Chinese high yield real estate bond universe is trading at distressed levels. The recent emphasis on improving the balance sheets and funding capacity of “essential” developers reflects regulators’ intent to support the sector and “fence in” better names. Homebuyer sentiment is also likely to improve on the back of the economic recovery and a revival in contracted sales. We believe that these factors have not yet been fully priced in by investors and that the sector should offer a source of potential upside in the coming months. In contrast, we are less optimistic about the outlook for duration. In our view, stronger growth and increased supply pressures should keep rates higher for most of 2023.
Such a backdrop, with a stronger credit market but higher interest rate outlook, can be incorporated into a total return strategy, allowing investors to potentially benefit from the upside potential associated with improvements in credit quality, while higher core yields provide a better carry environment should offer.
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