Bond market: Impact from coronavirus outbreak
As the number infected with new coronavirus in China continues to rise, panic over the outbreak has triggered a global risk-off, with Asian markets taking the largest hits.
Offshore HY property:
While fear is a common knee-jerk reaction, the Wuhan coronavirus outbreak will not destroy housing demand. Though negative impact is unavoidable in the near term, the effect is likely to be transitory and pent-up demand for property will resume once the epidemic is contained.
The imminent impact will be on property developers’ sales in 1Q20. We believe it could lead to softer contracted sales guidance in 2020 from the previous growth rate expectation of 10-30%. That said, while January and February are normally slack seasons for property sales, developers are expected to further postpone project launches to cope with the situation.
When it comes to developers with landbanks in the USD bond space, we do not foresee a big shortfall in saleable resources from developers to support a mild growth in contracted sales for the year. This is because most developers have a diversified landbank, and Hubei province (including Wuhan city) typically accounts for a single-digit percentage point of landbanking in gross floor area. On the liquidity side, amid expectation of slower sales in 1Q, developers are likely to remain financially prudent to preserve liquidity. As such, land purchases and new construction project will dip.
According to Standard and Poor’s, rated developers issued US$74bn worth of offshore bonds in 2019. Since the beginning of 2020, over US$17bn (IG:1.5bn; HY:15.9bn) worth of bonds have been issued, which already covers the majority of refinancing needs for 2020 at a total of US$23bn. The credit metrics are hence manageable unless the contagion stretches over an unreasonably long duration.
Against the uncertain market outlook, we expect policymakers to enact potential easing in addition to financing measures for developers, which will be positive in the mid-term.
The effects of the coronavirus will linger for at least another 2-3 months in our view and the hardest hit will be the travel and consumer related sectors. However, these sectors have relatively fewer bonds outstanding. Aside from property, the main components of offshore HY are energy, commodity, utility and local government financing vehicles (LGFVs), which are more resilient to epidemics, although some operating interruptions may surface during the prolonged Chinese New Year holiday. We expect the central government to enact wider stimulus plans for fixed investment from this year to make up for the decline in consumption.
We believe the coronavirus will affect the IG market in the short term. We feel constructive on IG given the uncertainty of the investment market. US treasury yields remain low and credit risk is holding up relatively well. In terms of duration, we will take profit on long-dated bonds and selectively add high beta names going forward.
Since mid-January, the epidemic has dented the RMB bond market. Yields of 10-year CGBs accelerated downward, falling below 3% in the last trading day before Spring Festival. We expect that the bond market this week to reflect economic shock and emotional panic, so yields will further slump.
We believe the month of February will be an important observation window. In the short term, attention will be on the epidemic but focus will return to macroeconomic fundamentals in the medium and long-term. Market sentiment will recover quickly should the number of new confirmed and suspected cases drop from their peak.
Companies are also facing greater pressures. The delays in resumptions to work (after Chinese New Year) and factory production postponements are affecting the secondary industry, particularly in the manufacturing industry. This also affects consumption and other tertiary industries.
Since we are of the view that the epidemic is a short-term factor for the credit market, overall credit risk is controllable. Hubei, the most seriously affected province, for example – with more than 500 billion RMB credit bonds, 70% of which are LGFV bonds, and 80% of the remaining’s issuers as state owned enterprises. In the current environment, we expect borrowers with weak fundamentals to come under refinancing pressures in the first and second quarter. However, we expect that the government will likely adjust their macro-control policies to maintain stability. In addition to targeted liquidity easing policies, we believe that further tax adjustment and expansion of special debt will follow thereafter.
We think that short-term interest rate bonds offer greater opportunities compared to corporate bonds, and we suggest extending the duration of rates. Meanwhile, we remain vigilant on the credit risk of weak issuers in business retail, clothing, media and other industries that are affected by the coronavirus.
Using SARS in 2003 as a point of reference for the current outbreak, it is inevitable that China’s economic growth will be compromised in the short term for the first half of 2020. As the epidemic is contained, the medium and long-term impact on the economy would be relatively small. Recall that China’s economy resumed an upward trend in the second half of 2003 after SARS cases were effectively controlled. We are keeping a close eye on changes in the situation – particularly to signs of epidemic control that may have reached a turning point, which may then signal that markets will return to normal. For now, we will pay attention to names that are oversold but are less affected by the epidemic.
The views expressed are the views of Value Partners Hong Kong Limited only and are subject to change based on market and other conditions. The information provided does not constitute investment advice and it should not be relied on as such. All materials have been obtained from sources believed to be reliable, but its accuracy is not guaranteed. This material contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.