Stagnating Dragon

Another week, and another data release showing China’s economic recovery is losing momentum, prompting analysts at several major banks to downgrade their growth outlooks for the world’s second-biggest economy. The disappointing figures, expected to be a renewed drag on global growth, further increased calls for the government to step up stimulus measures to boost the faltering economy. But investors aren’t waiting around, with data out last week showing foreign investors are sidestepping China and rushing into other emerging market Asian stocks instead. Over in the UK, the country finally got some long-awaited good news last week, with inflation falling more than expected to a 15-month low, prompting traders to pare back their bets for sharp interest rate hikes. Finally, cautious investors are becoming increasingly distrustful of this year’s stock market rally in Europe, and are rushing to snap up derivatives that would protect them should the good times stop rolling. Find out more in this week’s review.

Macro

China’s latest economic figures were out last week and showed that GDP in the world’s second-biggest economy expanded by 6.3% last quarter compared to the same time last year, helped by a low base effect considering that dozens of Chinese cities were in lockdown during much of 2022. The expansion was far below the 7.3% rate expected by economists. What’s more, on a quarter-on-quarter basis, the Chinese economy only grew by 0.8% – a far slower pace than the 2.2% registered in the first three months of the year.

The deceleration, which mainly comes down to falling exports, weak retail sales, and a continued contraction in property investment, is expected to put further pressure on the world economy. After all, the IMF forecasts that China will be the top contributor to global growth over the next five years, with a share expected to represent 22.6% of total world growth – double that of the US.

That’s why the poor GDP data further increased calls for the government to step up stimulus measures more than six months after it abandoned strict pandemic restrictions. But Beijing has so far only hinted at targeted measures limited in scale rather than broad ones, reflecting its conservative growth target of around 5% for the year. Government officials are also reluctant to drive up debt, especially in the property sector. The reality, though, is that China was still under Covid Zero rules in 2022, which gives a low base for comparison and makes the 5% growth target this year seem better than it really is. Netting out that effect, growth for 2023 will look closer to 3% – less than half the pre-pandemic average.

What’s more, China’s disappointing GDP figures prompted economists at several major banks to downgrade their growth outlooks. JPMorgan, Morgan Stanley, and Citigroup all cut their 2023 growth forecasts last week to 5%, putting the Chinese government’s official GDP target of the same figure at risk. The three banks’ previous projections were 5.5%, 5.7%, and 5.5% respectively.

Investors are voting with their feet, with new data out last week showing foreign investment in Asian emerging equity markets, excluding China, has surpassed inflows into the region's biggest economy for the first time in six years, reflecting diminishing investor confidence in Chinese growth. Over the past 12 months, net foreign investor inflows to emerging markets in Asia ex-China were more than $41 billion – outstripping net inflows of about $33 billion into mainland Chinese equities via Hong Kong’s Stock Connect trading scheme, according to data compiled by Goldman Sachs. The shift reflects the disappointing reality of China's poor recovery from strict pandemic restrictions, and shows how other economies in the region are benefiting from shifting supply chains and strong US demand for semiconductors, with microchip manufacturers in South Korea and Taiwan benefiting from the AI-driven demand surge.

Over in the UK, the country finally got some long-awaited good news last week, with inflation falling more than expected to a 15-month low. Consumer prices in Britain were 7.9% higher in June compared to the same time last year – the lowest reading since March 2022 and a sharp drop from the 8.7% rate registered in May. The figure was also lower than the 8.2% forecast by economists, marking the first time in five months that inflation came in lower than expected. Meanwhile, core inflation, which strips out volatile food and energy prices, dropped in June for the first time in five months to 6.9% from a 31-year high of 7.1% in May.

Despite the decline, inflation remains persistently high and the UK continues to be an international outlier, with consumer prices rising almost four times the Bank of England’s 2% target. In contrast, US inflation slowed to a 27-month low of 3% in June, while price growth dropped to a 17-month low of 5.5% in the eurozone. But at least inflation in the UK is finally heading in the right direction, which prompted traders to pare back bets for sharp increases in interest rates following the data. The market now sees interest rates in the UK peaking below 6%, down from as high as 6.5% priced earlier this month. The odds of a half-point rate hike in August, which was almost fully priced in before the data release, dropped to 50%.

Stocks

Cautious investors are becoming increasingly distrustful of this year’s stock market rally in Europe, and are rushing to snap up derivatives that would protect them should the good times stop rolling. Traders have been buying more and more put options, which hedge against falling prices, compared to call options, which pay out if the market goes up. That’s pushed up the ratio of puts to calls tied to the blue-chip Euro Stoxx 50 index to its highest level in at least a decade. The index – which includes luxury goods group LVMH, chip equipment maker ASML, and industrial conglomerate Siemens – has risen 15% this year to its highest level since 2007.

A key factor fuelling the caution is mounting concerns over slowing economic growth. The eurozone economy sank into a mild technical recession in June after two consecutive quarters of contraction. That could explain why analysts are expecting the current earnings season to show the biggest year-on-year decline in European profits since 2020. What’s more, the services sector, which accounts for approximately 70% of the eurozone economy, is starting to slow down. The S&P Global eurozone services PMI – a key measure of activity in the services sector – fell for a second straight month in June to 52. While that reading indicates ongoing expansion, it represents the slowest pace since January. That matters: according to the chief European economist at T. Rowe Price, services PMI in the bloc has been highly correlated with European share price movements over the past three years.

Finally, China’s poor GDP figures last week aren't helping matters either. See, European stocks’ outperformance this year was built on three key pillars: the avoidance of a full-blown energy crisis, the relative stability of the bloc’s banking sector, and hopes that the end of China’s lockdown measures would result in booming sales for Europe’s prominent luxury goods brands. While the first two have held up, the third is looking very shaky, with recent Chinese data displaying scant evidence of the big spending some had hoped for. Case in point: shares in European luxury goods firms LVMH and Hermes International dropped around 4% each last Monday after China’s GDP report. But the sector still looks expensive even after those moves, with the MSCI Europe Textiles Apparel & Luxury Goods Index trading at a 12-month forward P/E of around 28x – more than twice the MSCI Europe’s 13x.

This week

• Monday: US, Japan, eurozone, and UK PMIs (July).
• Tuesday: US consumer confidence (July). Earnings: 3M, General Electric, General Motors, Spotify, Alphabet, Microsoft, Snap, Visa, Verizon Communications.
• Wednesday: Fed interest rate announcement, US new home sales (June). Earnings: AT&T, Boeing, Coca-Cola, Meta Platforms.
• Thursday: European Central Bank interest rate announcement, US GDP (Q2), US durable goods orders (June). Earnings: AbbVie, Mastercard, McDonald’s, Ford, Intel, Mondelez.
• Friday: Bank of Japan interest rate announcement, eurozone economic sentiment (July). Earnings: Chevron, Exxon Mobil, Procter & Gamble.