Cross Asset Strategy
Stocks traded down this week as markets continued to focus on the earnings season amidst a quiet spell on the macro front, with a heavy week of reports. Around a third of the S&P 500 have now reported results, with a year-over-year earnings growth rate of -4.9%. This is a positive surprise compared to the -7% expected at the start of the earnings season. Over 80% of reporters have also surpassed consensus earnings estimates, above the one-year and five-year averages of 73% and 77% respectively. While there were some positive takeaways from a few high profile names, particularly in the large-cap tech sector, other sectors have traded weaker, especially on fears of further banking stress. It is notable that market depth is extraordinarily weak, with J.P. Morgan Investment Bank highlighting the narrowest stock leadership in an up market since the 1990s. Headlines around a potential U.S. debt ceiling stalemate also added another layer of uncertainty to markets, and potential spending cuts from Washington weighed on growth sentiment.
Despite lingering concerns over the U.S. outlook, a slew of positive macro data prints from China a couple of weeks ago reaffirmed the ongoing economic recovery, and one of the highlights was a significant rebound in domestic consumption. As China’s reopening continues, we believe the consumption recovery still has some further room to run. This also bodes well for the beneficiaries of Chinese tourism in the region and around the world, where we continue to see compelling opportunities in select sectors as the remaining impediments to a tourism rebound will likely fade away in the coming weeks and months.
Strategy Question: Who are the winners from China's tourism recovery?
As economies around the world eased mobility restrictions in the wake of the pandemic in 2022, consumers wholeheartedly reembraced travel, with one notable exception – China. The world’s largest tourism source market1 was among the last to drop its pandemic-related mobility restrictions after authorities exited a strict policy of “Zero Covid” at the end of last year. However, as a surge of Covid cases followed, many economies around the world retained or reinstated travel restrictions against passengers from China – and some have only been relaxed in recent weeks. The supply of international flights has also been constrained for a number of reasons. Thus, while a Chinese tourism rebound has been hotly anticipated by markets, we have yet to see the full extent of the recovery given these obstacles.
Why is Chinese tourism important? It is difficult to overstate the sheer magnitude and economic impact of this market. According to the United Nations World Tourism Organization, Chinese tourists spent a total of US$255 billion on international travel in 2019, and an estimated US$270 billion of potential value was lost in 2020 and 2021. Chinese tourism is especially critical to many economies in Asia and beyond. Some of the most exposed markets include Thailand and Hong Kong, along with tourism-oriented sectors in other economies such as Japan.
While the trajectory is positive, this recovery process has been uneven and nuanced due to lingering travel restrictions and flight constraints. We have characterized China’s reopening as a story of three phases: 1) domestic reopening, 2) reopening to Hong Kong and Macau, and 3) reopening to the world. For most of the world, the last remaining restrictions are being lifted on travelers from China. While markets have moved to price in this rebound to various degrees since China’s exit from Zero Covid last year, we believe the full extent of a Chinese tourism recovery has yet to be unleashed, and continue to see compelling investment opportunities in each of these phases within China and in the region.
Taking stock of China’s reopening
China’s domestic reopening has continued to gather pace in recent months. Consumption data has surprised to the upside – retail sales rebounded 10.6% year-over-year in March, and restaurant spending popped 27.1%. Though the jump is more likely due to a negative base in 2022 and making up for lost consumption during Covid lockdowns, we continue to see more room for recovery, particularly for services. After a couple of months of front-loaded rebound, the data is pointing towards a moderate – not strong – recovery from here, and that is how we see the rest of the year playing out for the China macro landscape. Looking at higher-frequency data, mobility within China has effectively normalized to pre-pandemic levels.
Nonetheless, there is somewhat of a disconnect between domestic and international reopenings. For example, while domestic flights have mostly recovered to the pre-pandemic average, reflecting normalization within China, international flight frequency remains well below pre-pandemic levels despite a recent rebound, with passenger volumes at just 12.4% in Q1 2023 compared to Q1 2019.2 The logistics of getting flight capacity back online tend to be more complicated and time-consuming than most expect, ranging from reallocating landing and gate slots for airports to redirecting planes and crew between existing routes for airlines. It is likely that constraints on the supply of flights (and lingering travel restrictions) have been weighing on outbound Chinese tourism, particularly to the rest of the world. High airfares in the region (also a phenomenon seen worldwide) also do not help with demand. As of April 3rd 2023, Skyscanner estimates that prices in the Asia Pacific region are currently ~33% higher relative to the same month in 2019 (whereas in Europe and North America those figures are just 12% and 17% respectively).
Looking forward, the ‘runway’ for air travel is looking more positive. According to J.P. Morgan Investment Bank, the anticipated increase in international flight capacity for the summer-autumn season could reach 60% of pre-pandemic levels, while regional capacity to Hong Kong, Macau and Taiwan is poised to recover to 87%. This is notable given domestic flight activity for tier-1 city airports in China is projected to decline slightly, reflecting a reallocation of resources towards international travel by airport operators. This is a signal of confidence and provides a strong foundation for the next phase of China’s tourism recovery to the region and the world. Some Chinese beneficiaries of increased international travel from China include duty free operators and travel agencies.
Macau and Hong Kong to benefit from Mainland reopening
We see Hong Kong and Macau as the key beneficiaries of the second phase of China’s reopening. Hong Kong has traditionally relied heavily on Mainland tourist arrivals to fuel retail spending, with tourism making up nearly 8% of GDP. Hong Kong-based corporates also benefit from Mainland demand, especially in the real estate and insurance sectors. Macau is one of the most tourism-geared economies in the world, with over 50% of GDP directly attributable to tourism and Mainland China making up the bulk of tourist arrivals. Both of these territories have seen a sharp rebound in Mainland Chinese tourist arrivals since the start of the year.
Macau in particular is highly geared towards a tourism rebound. With flights from Mainland China to Macau back at 65% of 2019 levels, gross gaming revenues (GGR) in the city have been on a rapid pace of recovery. After it reached an average daily run-rate of Macanese Pataca (MOP) 411m in March (that was ahead of market expectations), April is tracking at MOP 424m, suggesting that mass-market GGR may already be 70% of pre-Covid levels, or more. With the 5-day Labor Day “golden week” holidays to start on 29 April, it is likely that demand could inflect higher, boding well for May GGR. We see opportunities in select Macau casino operators in both equities and credit, particularly those well-positioned to capture the mass market opportunity and those with expansion potential.
Japan focus: rising investor interest amidst tourism rebound
One of the key international beneficiaries of a tourism recovery is Japan. After an initial post-reopening surge starting at the end of last year, Japan’s tourism arrivals saw yet another leg up in March, with international travel (ex-China) normalizing to pre-Covid levels. With interest in Japan rising with growing numbers of visitors, we reiterate being highly selective on what to own in the equity market, and we see more compelling upside potential for the currency.
Japanese authorities will downgrade Covid-19 to the same category as the seasonal flu on April 29th. All inbound restrictions will be removed, which will likely provide a further tailwind to pent-up inbound travel demand. While travelers from countries around Asia have been returning to Japan, difficulties in getting flights and impediments for Mainland Chinese (such as negative PCR test requirements and quarantine) have meant travel has remained depressed for this group of tourists. Mainland Chinese represented ~30% of inbound tourists to Japan in 2019 and are by far the biggest single group of travelers, meaning much of this recovery is still ahead of us. Beneficiaries of this recovery include select retailers, high-speed rail operators and consumption names.
On the Japanese Yen, we are bullish on a 12-month basis, making it a potential tailwind for equity investors. Over the past two years, interest rate differentials have driven 90% of the moves in USDJPY, making it the single most important driver for the currency pair. Last year, the sharp rise in USD rates caused a historic depreciation of the JPY. This could be reversed this year with USD rates peaking (or even declining as we move through the year) and the BoJ getting closer to policy normalization (at least to some extent). We favor implementing this view via option structures, taking advantage of attractive pricing due to deeply negative forward points.
Staying selective on recovery opportunities
Even as China’s reopening gathered pace, many obstacles have remained in the way of a full-fledged tourism rebound, especially internationally. We expect those impediments to diminish rapidly in the coming weeks and months, and to possibly provide a further tailwind to tourism beneficiaries, including select names and sectors in China, Macau and Japan. Beyond the region, an alternative way to gain exposure to China tourism can be via the European luxury goods sector.
All market and economic data as of April 27, 2023 and sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.
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