Fireworks from China vs fizzle from the S&P 500

US stocks turned in a listless performance Monday after the overnight melt-up in Chinese shares. China traded on buoyant economic news as well as trade optimism.

China’s best performers overnight were financials, led by the distressed-asset manager China Huarong, up 10.34% on the day. Nine of the ten top performers on the Hang Seng China Enterprises Index were insurance companies or brokers. On the Shenzhen 300 Index, financials rose by nearly 8%, followed by Infotech at +7% and materials at +6%.

More than a truce in the trade war is at work. The January new loan data, as I showed yesterday, reflects a measured reflation of the Chinese economy. For seasonal reasons the January data give an important signal about the state of the economy, and the healthy increase in new loans boosted confidence in the PBOC’s ability to keep credit flowing to the economy. The financials probably also benefited from expectations that China would continue to open capital markets to foreign investment.

European industrials with China exposure rallied sharply, and might offer a way to invest in Chinese growth at cheaper valuations than Chinese shares (see below).

US stocks were up less than half a percent, by contrast, as headwinds accumulated for the US economy. The Dow Jones average came close to its 2018 high before pulling back to a small gain. Factset reported Monday that “ten of the 11 sectors” of the S&P 500 “are projected to report a year-over-year decline in their net profit margins in Q1 2019,” marking the first year-on-year decline in S&P profitability since the fourth quarter of 2016. Earnings are expected to decline by 2.7% during the first quarter as well.

Bad news about the state of the US and world economy continues to accumulate. The Netherlands Central Planning Bureau reported a contraction of world export and import volume in December and a year-on-year decline in the volume of both imports and exports for the whole of 2018. Imports tend to be reported earlier than exports, so the January export data are likely to be ugly, in keeping with South Korea’s 5.8% YOY decline in January exports.

The Chicago Federal Reserve’s widely-followed National Index of Business Conditions meanwhile showed a sharp decline in January. The 3-month moving average of the Chicago Index has turned negative for the first time since mid-2017, and the declining trend will lend support to the argument that the Trump tax cuts gave the US a sugar high of consumption that now is wearing off.

Last week, the Commerce Department reported an unexpected 1.8% decline in retail sales excluding auto. Some analysts questioned the report, which might underreport online sales, but it underscores the fragility of the US household sector, the only driver of economic growth in an economy bedeviled by low capital investment, poor home sales, and falling exports.

It’s hard to justify chasing the Chinese rally, but investors who want to benefit from renewed optimism about the Chinese economy might consider the stocks of international companies with a big presence in China.

Volkswagen, the best-selling nameplate in China, rose over 3% in Germany today, and Daimler Benz rose 2.4%. VW is trading at just 6.5 times earnings and Daimler at 7.9 times earnings, cheaper than Great Wall Motor. A trifecta of trouble – a weak European economy, falling Chinese auto sales, and Draconian emission standards for Diesel engines – weakened the German automakers over the past year. They represent a cheaper China play than most Chinese stocks.

Other European stocks with heavy China exposure included Henkel AG, Airbus, SKF (Sweden), ABB, Alfa Laval, and Hexagon AG.