A deeper look at recovery data in China and the U.S.   

David Joy – Chief Market Strategist, Ameriprise Financial
Weekly markets commentary — May 26, 2020

Tension between the U.S. and China intensified last week. The U.S. Senate approved a bill requiring all foreign companies listed on U.S. stock exchanges to certify they are not under the control of a foreign government and be subject to audit by the Public Company Accounting Oversight Board (PCAOB). If a company does not comply with the certification, or the PCAOB is unable to conduct an audit for three consecutive years, a company will be delisted. While the bill would apply to all foreign companies, it is clearly directed at China, which prohibits such audit reviews. Companies such as Alibaba and Baidu are the most prominent names that would be affected, but there are more than 150 Chinese stocks listed in the U.S., with a total market cap north of $1 trillion, half of it accounted for by Alibaba, which also trades in Hong Kong after a secondary listing last year. The U.S. House has not taken up the bill, nor set a date for doing so. 

The obvious choice of listing in Hong Kong may no longer be as attractive as it was. China is imposing new security laws to enforce social discipline following the recent protests. How this alters the status of Hong Kong as an attractive money center remains to be seen, but it is worth noting that the Hang Seng index fell more than 5 percent on Friday after China’s intentions were announced. 

Economic data from China shows a slow recovery 

Aside from its differences with the U.S., the economic recovery from the coronavirus shutdown continues in China, but it is less than robust. The National People’s Congress, which continues through Wednesday, chose not to announce an economic growth target. The IMF forecasts GDP growth this year of just 1.2 percent, following a 6.1 percent pace last year. The COVID-19 outbreak appears to be contained, judging by the official numbers of 5,000 deaths and 100,000 cases in a country of 1.4 billion people, despite flareups in Wuhan and the northeast. 

The government is providing fiscal stimulus to promote activity and running sizeable deficits to do so. In what may be a condition experienced elsewhere as economies emerge from their own shutdowns, BCA Research notes that the supply side of the economy has reopened almost back to normal, but the demand side remains sluggish. And while the government is expanding credit availability, it works with a six-month lag historically, and compared to previous stimulus episodes it needs to be bigger. The private sector remains reluctant to spend and is not taking on debt. The growth that is occurring is the snapback from the lockdown. It is not yet a sustainable recovery. 

Data shows a modest rise in activity as states begin to open; equity investors remain optimistic 

Whether China’s experience will be analogous to our own is not yet clear. We are now at various stages of reopening in all fifty states and we can expect some degree of snapback activity as China is experiencing, but whether it gathers enough momentum to become a sustainable recovery remains to be seen, especially with the virus still relatively virulent. Some of the data sources that are available daily show a slow rise in activity from a very low base, understanding that not all regions of the country are open to an equal degree. For example, Open Table restaurant reservations on May 24 ran 88 percent below normal, but that is up from 99.9 percent below normal on April 30. Data from Moovit shows a slow climb in public transportation usage. On April 30, usage in Boston was 76 percent below normal, but improved to 71 percent below normal on May 20. And TSA checkpoint activity nationwide rose from 201,000 on May 10 to 267,000 on May 24. On May 24, 2019, that number was 2.1 million. 

Equity investors seem less tentative. The S&P 500® index added another 3.3 percent last week, bringing the surge from the March 23 low to 32 percent. Bond yields were little changed, with the ten-year ending the week at a yield of 0.69 percent and remaining in the 0.60-0.70 percent range that has persisted for the past six weeks. 

There was notable improvement, however, in high yield spreads. The ICE High Yield spread contracted 72 basis points to 706, continuing the improvement from March 23 when the spread blew out to 1,087. That does not mean that credit pressures do not persist in the below-investment-grade space. S&P Global reported that leveraged loans saw a record number of defaults in April totaling eleven, although the overall default rate remains low. For the year through April, the energy sector has accounted for the highest percentage of defaults at 30.5 percent. The leveraged loan index has recovered from the March low of 76 to a current 88, but remains below its 97 average of Jan.-Feb. The share of loans in deep distress, trading below 70, represents 9 percent of the total and is represented most heavily by oil & gas, retail and leisure. The pace of the economic recovery will have a large bearing on who survives and who does not.