Friday, October 30th, 2020

10 with 10% in China

The Chinese Consumer Goods sector now has the highest rating of any sector in our global sector matrix, with a recommended overweight of 85%, compared with a score of 82% for US Consumer Services and 71% for US Technology. Both sectors are rated relative to their own benchmark, but China also ranks higher than the US in our global country grid, which is calculated in USD. Only Taiwan and Denmark, which are one-stock wonders, rank higher.

This means that Consumer Goods in China is the highest-ranked sector in the highest-ranked large country in the world. For good measure, Chinese Consumer Services have the third highest ranking in our global matrix with a recommended overweight of 75%.

We make no apologies for hammering home this point. Everyone knows that increasing affluence in China is going to stimulate demand for a whole range of products and services, catering to all tastes and price points. The question is how to exploit it, and when. Our answer to the second question is undoubtedly now – as in this quarter, preferably yesterday. All great investment themes are a mix of pull and push factors. As discussed above, the pull factors have been obvious for years, but they have been thrown into sharp relief by the ease with which the Chinese economy has adapted to Covid, compared with the deep recessions in the US and Europe. The push factor is more explicitly related to financial markets and will depend on what happens to the US Tech sector.

Our models have been overweight in US Technology for most of this year, but that weighting started to fall in late July and our lead indicators now suggest that the sector will be downgraded to neutral sometime in November or early December. The detail behind this view can be found in our previous report, Fangs Can Bite You, (16th October 2020). The point is that there could be a large of pool of profits waiting to be reinvested in the next big idea.

Some of that will go into cyclical and infrastructure stocks in the US, but US investors may decide that it is time to look overseas. Although there are differences between aftermath of the Tech bust in 2000 and the period of profit-taking we foresee – hopefully there will be no equivalent of the Iraq War – one of the strategies which worked well in 2002-05 was a big overweight in Emerging Market equities. The Chinese Consumer story is the same idea, updated 20 years. If you are worried about how the Chinese authorities can generate this level of stimulus, think about oil at $35/bbl.

How to exploit this theme will depend on each individual investor’s benchmark. Some will already be allowed to buy Kweichow Moutai, China’s largest producer of wine which has a market cap of $311bn., sales growth of over 15% and an EBIT margin of 70%. Others will not be so fortunate. Even so, they should make plans to exploit and adapt their benchmarks wherever they can. According to FactSet, the market capitalisation of consumer-related stocks quoted in Hong Kong is $722bn. Alibaba is quoted in the US and unlike Amazon, we are increasing our overweight position rather than reducing it, both stocks measured against the S&P 500.

But there are still trades that European investors can do today, whatever their mandate, which will increase their exposure to the Chinese consumer. According to Factset, there are 10 consumer-related stocks in Europe which derive over 10% of their annual sales from mainland China. In descending order, they are Swatch, Adidas, Unilever, Puma, Carlsberg, Richemont, Hermes, Burberry, Moncler and Imperial Brands.

This data is based on the physical location of the sale and does not include sales to Chinese tourists when they are abroad. So other consumer stocks, such as LVMH, Kering, Dior, L’Oreal. Lindt, Danone, Pernod and Nestle (all of which have more than 5% of sales on mainland China) may also be above or close to 10% total exposure, when this is included.

We still have a neutral weighting on both Consumer sectors within Europe, partly because the domestic retail and hospitality sectors have been so badly affected by Covid and partly because some of the large caps in Food Retail are very mature businesses, while the Auto sector faces significant disruption. But this should not blind us to the scale of the opportunity on offer in selected stocks, or – in our view – the compelling need to diversify away from US Technology before the next period of underperformance.

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