Will China lead the recovery?

Companies in China appear best placed to emerge soonest and with least damage from the global coronavirus pandemic, according to a survey of Fidelity’s equity and fixed income analysts. Among those expecting the virus to lower earnings for the companies they cover, 85 per cent of our China analysts expect that hit to be contained to the first half of the year, compared to just 42 per cent of analysts covering other regions who expect the impact to extend into the second half. One industrials analyst reports: “In general my companies are expecting China to recover by the second half of the year, and production there is [already] back to around 70 per cent of capacity,” while a healthcare analyst notes: “It’s a very fluid situation but in China things are back to a 95 per cent manufacturing capacity.”

And despite 87 per cent of China analysts expecting the virus to damage profitability, the highest of any region, they expect the magnitude of that hit to be milder than other regions.

Since China was the first country afflicted by the virus it seems logical it will recover the fastest. But the time taken to resume business activity in countries struggling to cope with the outbreak will also depend in large part on the containment measures taken by individual governments. The Chinese authorities’ decision to impose strict travel restrictions in affected areas relatively early in the outbreak seems to have ensured the country will face a broad-based shock to the system, but will recover relatively quickly and with less of an impact to earnings overall.

China’s recovery may not be matched by other regions

In the West, efforts have centred on slowing the spread but avoiding economic shutdowns for as long as possible. The difference between the approaches is difficult to predict at this stage, but one consumer staples analysts covering North American firms cautions: “Be careful extrapolating a full shutdown in China to Western consumer behaviour.” And a US consumer discretionary analyst notes: “My base case is a very negative impact from the virus in the first half of the year which potentially bleeds into the third quarter due to changes in consumer behaviour and social avoidance.”

Many analysts covering companies in Asia, Europe and North America report that although production is now resuming in China, the knock-on effects to supply chains will be felt across the globe for some time to come. As one consumer discretionary analyst covering the Asia Pacific region puts it: “Supply chain concerns are the biggest focus right now, the difficulty of getting product not just out of China but also the slowdown in the supply chain more broadly. Demand implications and potential for this to get worse are less well managed and understood.”

However, the situation appears to be rapidly improving, highlighted by a European industrials analysts who notes: “As of 9th March, 92 per cent of the 140 Chinese factories important to my companies are open. Not one of those factories was open in February. Of the open factories, 27 per cent were running at high capacity and another 42 per cent were running at OK-ish capacity. One week prior to that the split was 2 and 11 per cent respectively, so the direction of travel is very positive at the moment.”

The technology sector also looks well placed to handle virus shock

Another area of the market that looks better positioned than others is the technology sector. Our analysts also expect the hit to earnings as a result of the virus outbreak to be shallower than other sectors. An IT analyst covering companies in emerging economies excluding Asia reports that “China seems to be back, so companies are actually quite positive.”

The technology sector has more recurring revenues that will mitigate liquidity concerns, while our analysts note that sub-sectors such as video games and remote working will see a boost as countries attempt to limit travel and social gathering. The manufacturing recovery in China is also helping - a North American technology analyst adds: “Capacity in China is back to 80 per cent from 40-50 per cent in February. People are going back to work. Most companies I have listened to on earnings calls have taken guidance down as a precaution but are expecting sales to be delayed rather than lost.” Technology companies are also amongst the most prepared for the outbreak getting worse - there is already a culture of working remotely and of all the sectors it has the technology to do so

The Fidelity Quarterly Sentiment Tracker for March 2020 features 185 responses from 152 analysts (analysts who cover more than one region or sector take the survey once for each sector/region combination). The survey was conducted between 7 March and 12 March.