The economy of China is deteriorating due to a power deficit, Covid-related limitations, debt instability in the property sector, and government crackdowns on a variety of businesses. European firms who sell a lot of stuff to China have already suffered, but U.S. multinationals — and the S&P 500 — could be in for more suffering.
Construction materials, mining, automobiles, and consumer durables like luxury goods, which are all exposed to China, are already lagging well behind the market, according to Bank of America strategist Savita Subramanian in a recent note to investors. Construction materials, mining, and automobiles all have forward price-earnings ratios that are approaching historic lows in Europe. Stocks having the most exposure to China, including miners BHP Group and Rio Tinto, as well as luxury goods companies like Swatch Group and Cie. Financière Richemont, have been struck particularly hard.
This is in contrast to US firms with significant China exposure. According to Subramanian, valuations for companies with a lot of sales to China have declined at a slower rate than the overall market, leaving the bank's basket of companies with the most exposure trading at a 20% premium to their peers — and that's without including Tesla, a highly valued company with a lot of business in China. The U.S. stock market's resiliency may be due to the dominance of technology and hopes for a capital-spending boom that would help some of those firms, but Subramanian still sees a problem. Subramanian stated, "This risk premium appears to be excessively low, especially in view of our experts' bear case forecast" for China's economy.
It's possible that the pain will be severe. The economists at Bank of America are pessimistic. They cut their forecasts for China's economic growth by 0.3 percentage point this year and 1.3 percentage points next year, putting their predictions towards the bottom of the spectrum of experts' expectations. Their fear is that China's authorities have been too sluggish to change monetary or fiscal policy in response to the downturn. In a separate research note, the firm's Asia strategists stated that their stoicism in the face of recent weakness shows that this may be a "once-in-two-decade reorganization of the Chinese economy." "If that's the case, China's data flow might confuse even the pessimists, and we're watching for that to happen."
Indeed, the China investment strategists at BCA Research say there is reason to anticipate that economic stimulus will not be forthcoming. While worries that economic slowdown might damage China's job market, stifling household spending, have prompted authorities to adopt measures to boost growth in the past, consumption is holding up pretty well, according to BCA. This may lessen the need for policymakers to act, especially because electricity shortages cannot be alleviated by stimulus.
The takeaway: According to a recent BCA analysis, "a dramatic re-acceleration in China's economy is not yet likely."
And for the S&P 500, this may mean problems. As a consequence of factors such as a fraying of globalization and more protectionist behavior as the US and China strive to lessen their dependence on each other, BofA says its drop to its forecast for GDP growth equates to a 4.4 percent damage to S&P 500 profits per share.
Materials and technology companies in the United States are particularly sensitive to a slower-growing China, since their earnings are more closely linked to China's GDP growth than to the rate at which the US economy develops.
The danger has been identified by active fund managers. According to Subramanian, they are underweight China-exposed equities compared to the S&P 500. As the threats to the world's second-largest economy rise, other investors may want to follow.
The repercussions are expected to be extensive.
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