China momentum is the big mover in world markets

Europe and the US both reported weaker-than-expected results from purchasing managers’ indices on Thursday, with German manufacturing deeply in contraction territory and the American composite PMI showing it weakest reading in three years.

China-related shares in Europe nonetheless continued to rise. Daimler was the top performer on Germany’s DAX index with a 2.12% gain overnight and a 29% total return year to date.

The big economic story of 2019 remains better-than-expected growth in China and worse-than-expected growth in the US. China has managed to reverse a late-2018 drop in growth impulse, while the American picture has deteriorated. That begs the question of whether the US or China suffered more from the Trump tariffs.

The Caixin and Markit PMIs show the percent of respondents whose business is expanding. They reflect momentum rather than absolute levels of growth. China’s GDP grew at 6.4% in the first quarter, and the US appears to be growing at an annual rate of less than 2%.

Markit’s chief business economist Chris Williamson commented on today’s data release:

“The US economy started the second quarter with its weakest expansion since mid-2016 as businesses reported a marked slowing in output, new orders and hiring.

“The survey indicates that the manufacturing downturn seen in the first quarter has persisted into April, but growth in the service sector has now also slumped to a two-year low as the malaise showed further signs of spreading beyond the factory sector.

“The April surveys are consistent with GDP rising at an annualized rate of just under 2%, with the official measure of manufacturing production remaining in decline.

“April also saw firms become more reluctant to hire as a result of weaker order book growth, pushing jobs growth to a two-year low.”

Capital investment remains extremely weak, the victim of supply-chain uncertainties arising from the trade war. US retail sales for March printed on Thursday a bit better than expected, taking the year-on-year change to 3.6% for sales excluding food and autos. Household spending is almost certainly strong enough to exclude the possibility of a recession in 2019. Growth nonetheless remains weak. US bond yields fell despite the strong retail number.

Internationally, German industrial output remains weak. Global weakness in capital investment hurts Germany disproportionately, yet German equities have outperformed during April. The DAX index is up 6% in April, compared to a 2.6% gain in the S&P 500. Evidently, the market is looking over the rise to prospective improvement as the Chinese economy improves.

I’ve argued on several past occasions that some European stocks are a cheap way to buy Chinese growth. VW is China’s bestselling auto nameplate, and China accounts for half of VW’s revenues and most of its growth. Yet VW now trades at around 6 times forward earnings, compared to 11 times earnings for Great Wall Auto’s Hong Kong H-shares.

VW’s correlation with the Shanghai Composite Index is now as close as it is with Germany’s DAX index. In other words, VW is trading like a Chinese stock, which should not be a surprise. The point is that it is a relatively cheap Chinese stock.