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China’s importance in global equity valuations

06744 CC Trader Talk V2

The developed world needs to come to terms with the fact that China is the world’s second largest economy and in some ways soon to become the leading economic force globally. Today China matters more than ever for equity valuations worldwide. In the years after the 2008 global financial crisis, China’s contribution to global GDP growth increased remarkably, making it a key barometer for ‘risk-on, risk-off’ perceptions.

The developed world has to be careful when placing tariffs on Chinese goods that could end up sending the world into a recession. President Donald Trump tried to send a message that the US can keep its pace of growth despite its attack on the Chinese economy. Nonetheless, it wasn’t too long before US companies started to sound the alarm bells in the first few weeks of 2019.

Apple CEO Tim Cook was the first to send a chill through Wall Street and the tech industry by cutting its sales forecasts for the first time since 2002, blaming a sharper than expected economic slowdown in China.

Whether Trump wants to accept it or not, the best days for the US economy are behind us and the EU’s growth forecast is hanging on a thread. The U-turn by both the Federal Reserve and the European Central Bank to remain accommodative confirms this assumption. Being in the late stage of the economic cycle, it is imperative that the developed world does not come up with ways and means which will hinder growth in China.

China is not immune to the negative forces threatening growth in the developed world. In fact, its official goal for economic growth in 2019 was lowered to a range of between six to 6.5 per cent, as policymakers seek to pull off a gradual deceleration while grappling with a trade war with the US.

The Peoples’ Bank of China and the Chinese government are coming up with ways and means to try and keep growth above the six per cent level. China offered wide ranging tax cuts, particularly reductions in value-added taxes, and a signal for monetary support.

China’s emergence has had a positive impact on many sectors, above all on commodity prices. Its rapid growth, high energy per unit of GDP requirements and rapid urbanisation have kept energy prices well supported.

When we look at equity valuations, we realise that, many times, the forecast growth is expected to come from emerging markets. We are interested in companies that are exposed to this growing middle-class spend by Chinese consumers. This growth in middle-income households combined with urbanisation, denser cities and the desire for higher quality products are all driving strong, long-term, sustainable growth.

In the energy sector, we have a favourable outlook on companies like Total, Royal Dutch Shell and Enel.

In the beauty sector we recommend L’Oreal. The group recently reported that growth continues to be boosted by Chinese consumers, especially for premium brands. By some estimates 80 per cent of middle-class household growth globally over the next few years will come from Asia, with the bulk of that from China.

Both Kering (owner of Gucci and Saint Laurent) and LVMH (Louis Vuitton) look good. Both fashion companies shrugged off fears about waning demand from the key Chinese market. Chinese consumers are becoming the driving force of economic growth. There are currently over 400 million millennials in China. Since the first were born in the 80s they have seen China’s GDP grow more than 20-fold. They spend a lot more compared with their parents’ generation and we see different spending patterns – they pay more for quality brands.

In eCommerce, we recommend holding to Alibaba equity, which has become one of the world’s biggest internet companies thanks to the growing wealth and online shopping habits of Chinese consumers.

Within the sector of packaged foods industry, there is Danone. The French food producer plans to distribute more health-focused food and beverages in China, in an effort to keep up with changing local lifestyles.

Airbus looks favourable within the transportation sector. China will need over 7,400 new passenger aircraft and freighters from 2018 to 2037, with a total market value of $1,060 billion, according to Airbus’ latest China Market Forecast.It represents more than 19 per cent of total world demand for over 37,400 new aircraft in the next 20 years.

The entertainment sector sees Disney as one of the favourites. Last year, Disney’s CEO Bob Iger opened an expansion to what is proving to be one of Walt Disney Co.’s most successfultheme parks. He said the $5.5 billion Shanghai Disney Resort will keep expanding to satisfy Chinese consumers’ strong and growing demand for high-quality themed entertainment.

Nowadays, China is a major contributor to equity valuations. Our base case scenario is that the US and China will end the trade war and additional policies will be put into place to support growth rather than destroy it. Hopefully, the markets will continue to price in a better economic environment. It is appropriate to conclude with a quote from Alibaba’s Jack Ma, who said: “The US-China trade war is the stupidest thing in the world!”

The Calamatta Cuschieri Traders Blog is available daily on CC WebTrader. Other market coverage including coverage of the International Bond Markets is also available.

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