Buried under the recent news of war in Ukraine and inflation everywhere else, the slowing of Chinese economic growth could yet prove to be the greatest — and most widely ignored — threat to European equity capital markets.
The National Bureau of Statistics of China this week said export growth had slumped to its lowest increase since the nadir of the Covid-19 pandemic in summer 2020. In April, exports were 3.9% higher year-on-year, down from a 14.7% increase in March.
In the first quarter of 2022, China’s GDP grew by 4.8% year-on-year to $3.981tr, according to the bureau.
Forecasts predict GDP growth of around 4.4% for 2022. In 2021, the economy grew by 8.1%. For the past decade, the lowest growth rate was 5.95%, in 2019.
Producer prices increased by 8% in March compared with last year. On average, producer prices have increased by 1.47% per year since 1995.
Analysts from ING to Fitch Ratings are lowering their economic forecasts for China for the whole year.
“Out of the three big risks — the quantitative tightening in the US, the war in Ukraine, and what is going on in China — China is probably the most underappreciated of the swing factors,” said an equity capital markets banker in London. “It is the one that people are less focused on and therefore where the biggest surprise might come from."
Others shared the sentiment that market participants were are not aware enough of the threats coming from Asia.
“People don’t talk about that as much as they should,” said a second ECM banker at a bulge bracket bank in London. “The big worry is real growth in China. More and more it is looking like growth in China is actually negative when adjusted for inflation. That is a huge shock. If you really want to be bearish, China is the problem.”
Worries about the future of the the Chinese economy were a major talking point before the pandemic. Its problems have not disappeared. If anything, they have become more pronounced as draconian lockdowns under the country’s zero-Covid strategy put pressure on production and supply chains. Factories have been shut down and consumers have been forced to stay at home or in special isolation facilities, while ports are also closed.
“When you’ve got a huge adjustment in economic growth in China, that’s going to be a massive problem for the world,” said the first banker. “Because what is long forgotten is that, as much as the Fed, it was the Chinese stimulus that saved the day back in 2009.”
What works in one direction can also have the opposite effect, he argued: “Because of massive lockdowns in China it’s going to be difficult for asset prices to hold up in a context where economic growth is slowing down.”
Impaired public offerings
An equity capital markets banker in northern Europe said he was beginning to see the cracks when working with companies looking to go public.
“In IPO processes, where people are getting ready to come to the market and have to present a three year history, the impact on business models and operating performance is certainly beginning to bite,” he said.
“We see it in any sector where part of the value chain is in Asia, whether you are manufacturing out there or buying from there. That certainly is a big concern.”
Companies in luxury, travel and manufacturing sectors will be hit the hardest, several bankers and investors agreed.
The stock price of global luxury conglomerate LVMH, a company famous for its crisis resilience, is down by 22.6% since the beginning of the year. “Many of the larger luxury companies have already repriced or are still being repriced,” said Mathieu Chabran, co-founder of the alternative asset management firm Tikehau Capital.
A weakening Chinese economy could also affect Swiss skincare company Galderma, which is considered one of the most likely candidates to reopen the European IPO market before the summer.
Wealthy, image-conscious Chinese women have been a growing target audience for Galderma in recent years. In autumn 2021, the company took part in China’s International Import Expo for the first time as part of its strategy to accelerate expansion in the Chinese market.
Some still believe in the resilience of Chinese consumer appetite for luxury goods. After all, slowing growth will not wipe out the prosperity of the past decade. “Famous last words, but during Covid-19, everyone assumed that luxury would get hit,” said another banker at a large US bank in London. “Think of all the wealth that was created over the last 10 years in that part of the world.”
But the buy side is beginning to worry about the results of Chinese businesses. “We are concerned that the Q2 numbers being reported from China during the summer are going to be very weak,” said Chabran. “There are going to be some significant consequences on a micro level, in our view. That comes with a combination of much higher cost of funding worldwide, interest rates and credit spreads. So you have a bit of a perfect storm that could hit at the end of Q2.”
ECM shocks
Equity capital markets have had to grow used to emergencies in the past two years — but in contrast to the pandemic or the invasion of Ukraine, the stalling of the global growth engine that is China is not going to be a short, sharp shock but will be part of a much greater shift.
“For us, it’s not a crack like the war in February or Covid in March 2020,” Chabran added. “It’s not a Lehman Brothers moment; it’s not falling off a cliff. We have started a new cycle where money has a cost.”
Many bankers and investors in conversation with GlobalCapital have echoed this sentiment of entering a new era. Most of them pointed towards the challenges of adjusting to this secular change, especially for junior employees who have never seen rate rises and bear markets.
However, the changes are not universally negative. Some instead have focused on the opportunities that are opening up.
“There are plenty of silver linings for investors,” said Chabran. “Globalisation is being hit back. This again creates massive opportunities. For example, Tikehau Capital just announced a regenerative agricultural project with Unilever and French insurance company Axa.”
In China’s case, companies that do not depend on Asian markets could even benefit from lower production activity in the East. One equities analyst specialised in central and eastern Europe said that for the companies he looks at, the indirect effects on commodities prices are stronger than the direct effects on revenue.
“If Chinese growth slows down,” he said, “this would offer relaxation to prices on energy, oil, steel, coal and so on.”