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The coronavirus' effects could last longer than expected.
The majority of commentators are saying China will slowly get back to work by the end of the first quarter. Investors will stay fairly steady throughout this period knowing that coronavirus will result only in a temporary knock on corporate profits and general economic activity. Ultimately, like in 2003 when SARS gripped the nation, China will rally to a V-shaped recovery — that is, a quick fall in economy activity followed by a sharp return to normalcy soon after. Markets are overreacting.
Be aware, these commentators may be wrong.
The country's economy is growing much more slowly now (GDP growth has recently been about 6%, according to the government, compared with 10% in 2003 – when SARS hit) and the banking system is far more fragile and laden with debt.
To understand the economic predicament China finds itself in, you have to remember what was happening in China about a year ago completely aside from the trade conflict with the US. Last year it seemed the Chinese economy might come apart at the seams, as credit had dried up for the private sector — which is where most of the country's growth comes from — and consumers dramatically slowed spending.
In May 2019, Chinese regulators had to bail out a bank, Baoshang Bank, for the first time in decades. A few more bailouts followed, and suddenly banks became scared to lend to each other. By June, the Chinese Communist Party was forced to gather all the banks, tell them to get their acts together, and demand that they take haircuts on their investments in each other (a concept the bankers had lost familiarity with during the state's post-crisis credit spree).
It is no surprise, then, that the creditworthiness of the Chinese banking system has been trending downward, especially at the lower end.
Because of the coronavirus, this weakened banking system — less than one year out from being on a bit of a brink — will now have to forgive loans for companies large and small and continue financing local governments dealing with the fallout from stagnating economies and the effort to fight the coronavirus. S&P research estimated that if this crisis is prolonged, bad debt in the banking system could increase from 2% at the end of last year to over 6%.
China's other financial-system struggle over the past year was ensuring that private-sector companies, mostly small and medium-size enterprises (SMEs), were getting adequate funding. A lot of these companies used to get financing from China's shadow-banking system, so when authorities cracked down on that in 2017 and 2018, they got squeezed. This is incredibly important. Chinese state media reported that in 2018, the private sector accounted for 50% of tax revenue, 60% of GDP, and 90% of new jobs and new firms.
There are many other indicators suggesting we are indeed living in a time where markets could fall at any time.
As mentioned in previous blogs, our view is clients should be prepared for market turmoil – including the possibility of a global market correction or even market crash (including potentially moving their investment portfolios to very defensive risk profiles).
As always talk to your adviser within the Just Service network if you would like information or otherwise review your savings, investment or pension plans.
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Regards
The Just Service Client Service Team
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