The Chinese economy is criticized. The S&P 500 could take the next hit.
The outlook for the Chinese economy is worsening as the country suffers from an electricity shortage, Covid-related restrictions, debt turmoil in its real estate sector, and government crackdowns on various businesses. European companies with strong sales in China have already taken a hard hit, but the pain could still be ahead for US multinationals – and the
European sectors exposed to China such as building materials, mining, automobiles and durable consumer goods such as luxury goods, are already far behind the market,
Bank of America
wrote strategist Savita Subramanian in a recent note to clients. Futures price-to-earnings ratios for building materials, mining and autos in Europe are close to their all-time lows. The stocks most exposed to China, such as mining companies BHP Group (BHP) and Rio Tinto (RIO), as well as luxury goods makers like
(UHR.Switzerland) and Cie. Financière Richemont (CFR.Switzerland) – are among the hardest hit.
This contrasts with US companies heavily exposed to China. Subramanian says the valuations of companies with high sales in China have fallen less than for the market as a whole, leaving the bank’s most exposed basket of companies at a 20% premium to their peers, without even count Tesla (TSLA), a highly regarded company with a big deal in China. The dominance of technology in the U.S. stock market and expectations of a capital spending boom that would help some of these companies may be the root of the resilience of the U.S. market, but Subramanian still sees a problem.
“This risk premium seems too low, especially in light of our economists’ bearish scenario” for the Chinese economy, Subramanian wrote.
The pain could be sharp. Bank of America economists are bearish. They cut their estimates of China’s economic growth by 0.3 percentage points for this year and 1.3 percentage points for next year, leaving their calls near the low end of economists’ expectations. Their concern is that the Chinese authorities have been too slow to respond to the slowdown by adjusting their monetary or fiscal policy. Their stoicism in the face of recent weakness suggests to economists that this could mark a “restructuring of the Chinese economy once every two decades,” the company’s Asian strategists wrote in a separate research note. “If so, the flow of data from China could confuse even pessimists, and we are on our guard for this scenario to unfold. “
Indeed, BCA Research’s China investment strategists see reason to believe that the economic recovery may not be forthcoming. While fears that economic weakness could hurt China’s labor market, reducing household spending, have prompted authorities to take measures to support growth in the past, consumption is holding up relatively well and the unemployment rate has fallen. , according to BCA. This could eliminate the urgency for policymakers to take action, especially since electricity shortages cannot be alleviated by stimulus measures.
The takeaway: “A decisive re-acceleration of the Chinese economy is not yet imminent,” says a recent BCA report.
And that could cause problems for the S&P 500. BofA says its reduction in its call for gross domestic product growth translates into a 4.4% impact on the S&P 500 earnings per share, the result of factors such as the unraveling of globalization and more protectionist behavior as the United States and China are trying to reduce their mutual dependence.
US materials and tech stocks are most vulnerable to slower Chinese growth: their earnings are more correlated to Chinese GDP growth than to the speed at which the US economy is growing.
Active fund managers have spotted the risk. Subramanian said, noting that they are underweight stocks exposed to China relative to the S&P 500. Other investors may want to follow as risks to the world’s second largest economy increase.
The ripples are likely to be far-reaching.
Write to Reshma Kapadia at [email protected]