China getting a head start in recovery from mayhem

Mainland Chinese stocks and bonds are emerging ahead of the pack from the global maelstrom unleashed by the coronavirus outbreak in the Chinese city of Wuhan.

Market veterans say the apparent success of the draconian steps China's government took to contain the virus, officially know as COVID-19, and the effectiveness of its stimulus measures are adding to the allure now of both locally listed A shares and Chinese government bonds.

The latest update from China's National Health Commission on March 20 reported that over the prior 48 hours there were no new cases in Wuhan, the city where the virus is believed to have originated in late 2019, for the first time since the commission began posting daily briefings in late January. As recently as four weeks ago, the commission was reporting thousands of new cases there each day.

Meanwhile, the 73 new cases confirmed in the rest of the country for March 18-19, mostly in Beijing, all involved infected people entering the country from abroad.

China, the first country to be hit by the virus, has become the first country to bring the outbreak under control, said Chin Ping Chia, Hong Kong-based managing director, head of business strategy and development, China A investments, with Invesco Ltd.

As a result, the panic sweeping through global financial markets now isn't being seen in China, said Mr. Chia, noting that a lot of investors appear willing to look beyond the ugly short-term hit the country's economy is taking to contain the virus.

"China has emerged as an unlikely safe haven," given both the stability of its yuan in foreign-exchange markets and the fact that the A-shares market has held up better than expected," said Aaron Costello, consultant Cambridge Associates LLC's Singapore-based regional head for Asia.

In a first quarter that's seen the coronavirus tag a number of markets in the region with losses of 25% to 35%, Shenzhen and Shanghai have been top performers. Shenzhen, home to a greater proportion of listed companies focused on domestic demand, leads the regional pack with a year-to-date decline of roughly 1%, while Shanghai, with companies more exposed to international trade, is off 10%.

March 19's Asian trading day followed a recent pattern, with mainland stocks emerging relatively unscathed after Wall Street and other major markets had their knees capped overnight. Following yet another 1,000 point — or 6.3% — hit for the Dow Jones Industrial Average on March 18, the Shanghai Composite Stock index dropped by less than 1% while the Shenzhen composite posted the region's only gain for the day, rising 0.28%.

In markets roiled by rampant uncertainty, China's success at choking off the spread of the virus, using command and control tactics Western democracies would be hard-pressed to emulate, is helping investors look beyond what will inevitably be gut-wrenching economic reports for the coming quarter or two.

David Chao, Hong Kong-based global market strategist, Asia-Pacific (ex-Japan) with Invesco, said his team continues "to favor Chinese equities … given how swiftly the Chinese authorities were able to curtail" the spread of COVID-19.

That progress has come as other countries, including the U.S., struggle to get ahead of the curve, he said.

Mr. Chao said investors should likewise be paying more attention to Chinese investment-grade corporate bonds. "We've recently seen an uptick in foreign fund flow into Chinese bonds as perceived safe-haven assets in light of a slowing global economy," he said, adding the yuan has also held up well compared to other emerging market currencies, as Beijing looks to shore up market confidence and ensure financial conditions are healthy.

Invesco managed $82 billion in China assets as of Dec. 31.

The same top-down powers China deployed to halt the spread of the virus is proving effective as well in crafting targeted stimulus measures, such as providing needed liquidity to the small- and medium-size enterprises that account for the bulk of the country's job growth, said George Efstathopoulos, a Hong Kong-based portfolio manager with Fidelity International.

The "unprecedented draconian" steps China took to stop the virus are resulting in sharp declines now for the country's economy but that short-term pain could be setting the stage for a healthy recovery, he said.

While the steps China's government took, such as quarantining tens of millions of citizens for a month or so, would be challenging for most other countries, it was arguably the kind of strong leadership that should prove reassuring for market players, said Jason Hsu, founder and chairman of Rayliant Global Advisors, a manager running "quantamental" strategies with $1 billion in assets under management and $29 billion in a legacy-licensed business.

Meanwhile, the broader ripple effects of the coronavirus outbreak for world markets could likewise prompt a pickup in flows to mainland stocks and bonds as the dust settles.

Mr. Hsu said the current plunge in U.S. stock prices should dent the "unlimited optimism" that led many investors over the past decade to effectively throw out the diversification playbook and double down on U.S. equities.

For now, most asset owners are "shellshocked," but the fact that mainland stocks are relatively less expensive and have faster growth in earnings per share "will start to be attractive to people willing to look," Mr. Hsu said.

The diversification argument should favor China government bonds as well, according to market veterans.

"We anticipate increased demand for CGBs in light of the current global market turmoil," with diversification benefits in terms of their liquidity profile as well as returns, said Stephen Chang, Hong Kong-based executive vice president and portfolio manager with Pacific Investment Management Co. LLC.

Meanwhile, against a backdrop of aggressive monetary easing by the Federal Reserve, the yield on the 10-year U.S. Treasury fell briefly to historic lows below 1% earlier in March — opening up the widest spread in five years with the yield on 10-year Chinese government bonds, which kept above 2.5%.

"If you look around the world, there's a declining number of marginally attractive haven assets," but China fits the bill, with the added attraction of a very stable currency, said Jason Pang, a Hong Kong-based fixed-income portfolio manager with J.P. Morgan Asset Management. "We've been overweight Chinese bonds for some time (and) over the past few months, we've been increasing our China duration overweight," he said.

The widening "differential between China government bonds and other global government bonds have made China government bonds more attractive, with higher yield pickup," said Kheng Siang Ng, Singapore-based head of fixed income, Asia-Pacific, with State Street Global Advisors.

"This will support the ... case for investing in China bonds as part of core investments to reap the benefits of portfolio diversification and yield enhancement," he said.

Still, some market veterans said strong demand for U.S. Treasuries could persist even in an extremely low-yield environment.

Jim Veneau, Hong Kong-based head of fixed income, Asia, with AXA Investment Managers, said recent experience in Europe has shown its possible for investors to garner good total returns on negative-yielding bonds "as long as buyers continue to drive the price up" and push yields even lower.

"Once we've broken through the psychological barriers of record-low yields (U.S.) and negative yields (Europe), investors will still buy when they want a safe haven," he said.

Still, the yield pickup offered by China government bonds now is a further inducement for foreign investors already poised to increase allocations with the inclusion of China government bonds to J.P. Morgan's suite of emerging market bond indexes on Feb. 28, noted Wilfred Wee, Singapore-based portfolio manager with Investec Asset Management Ltd.

The J.P. Morgan inclusion marks a significant — if still early — step in the mainstreaming of China's onshore bond market for foreign investors, Mr. Wee said.

Meanwhile, even if the "relative calm in Chinese assets" proves ephemeral, a more volatile backdrop could offer opportunities as well as risks for foreign investors and managers, Cambridge Associates' Mr. Costello said.

With the prospect of a liquidity squeeze coming, "the next big challenge is the potential rise in corporate defaults in China, especially among private enterprises and SMEs," Mr. Costello said. While many foreign investors have avoided the credit space in China, "some of the credit managers we follow are looking closer and looking for opportunities" now, he noted.