‘Increasing anxiety’ over covid resurgence in China

Markets do not seem to be fully registering the threat the Delta variant poses

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Concerns over the spread of the Delta variant of covid in China has led to the LGIM Asset Allocation team to become more cautious on risk assets across its £70bn ($96bn, €81.8bn) multi asset portfolios.

Following the well-established team process means that all portfolios have reduced risk including the popular Multi-Index fund range, managed by Justin Onuekwusi.

While risk assets have remained robust, with some equity markets touching new highs, Emiel van den Heiligenberg, head of Asset Allocation at LGIM, said it is becoming “increasingly anxious” about the threat the Delta variant poses in China, which he added is something markets do not appear to be anticipating.

Fall in capacity

Despite it being early days, van den Heiligenberg said the variant seems to have spread too far in the world’s second largest economy to be easily contained with regional measures.

“Delta cases have now been reported in over half of China’s provincial regions, including Beijing, and over 90% are now warning against unnecessary travel,” he said. “Airline capacity in China has fallen by 10% over the past week as virus concerns have started to spread.”

For LGIM, this raises the prospect of a scenario in which the Chinese authorities come down hard and contain the virus within one quarter, as which took place in early 2020.

If this happens, van den Heiligenberg said it could lower Chinese growth from a seasonally adjusted annual rate of 5% to zero over a three-month period. Implying this, knocks full-year Chinese growth down from 5% to below 4%, he added this could have the effect of slowing world and US economic growth by 0.6% and 0.2% respectively,

“Emerging markets would probably be worse affected than the US and Europe, slowing by about 0.6-0.7%,” he added. “Those in Asia would likely be hardest hit, followed by Latin America and CEEMEA (Central and Eastern Europe Middle East and Africa).”

Prudent step

As a result, van den Heiligenberg said the LGIM Asset Allocation team is lightening its bullish stance on risk assets.

“With the S&P 500 close to an all-time high, we think this is a prudent step against the threat of this scenario playing out,” he said. “Because we are reacting to a developing risk that only has the potential to be significant, this view change may have a relatively short shelf life. Six weeks from now, we will probably know whether the risk has crystallised or not.”

Despite these short-term concerns, van den Heiligenberg added that the Asset Allocation team is not  turning completely neutral or even bearish on risk assets. This is because the case to remain bullish view over the medium-term remains.

“The global economy has transitioned to mid cycle, consumers have excess savings to spend, and central banks are still extremely supportive,” he said.