Fra BNP Paribas
We have been highlighting the key risks to European Credit in the last few editions of the Credit Plus and might have sounded too bearish on the headline. Despite the Fed being less hawkish than before it was not conclusive enough to assume that the tightening cycle is being actively reviewed.
As such a major driver of support for risk assets and Credit is to be awaited. Thus, sadly the Credit market is still in captivity to external headlines and we retain our cautious outlook in the near term due to the issues mentioned below. China threat to the fore in the first two weeks of February The main reason for a cautious outlook remains China.
Despite Central banks like the ECB and the BoJ propping up the markets with dovish headlines, the fact that the Fed is still in tightening mode (as of now) and the ever present Chinese shocks means that no rally is sustainable, at least until we hit the bottom of this Chinese downturn, or until the Fed stops the gradual hiking cycle.
Given that backdrop, we are concerned about the raft of Chinese data coming up in the first two weeks of February. All the monthly releases for January, including the official and unofficial PMIs and monthly reserve numbers, come out during this period.
The full calendar is in Table 1
February Event
01 Manufacturing PMI
01 Non-manufacturing PMI
01 Caixin China PMI Mfg
03 Caixin China PMI Services, Composite
07 Foreign Reserves
08 Foreign Direct Investment YoY CNY
10 Aggregate Financing CNY
10 Money Supply M0, M1, M2 YoY
10 New Yuan Loans CNY
15 Trade Balance
15 Exports YoY
15 Imports YoY
18 CPI YoY
18 PPI YoY
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With a slowdown in Chinese growth expected by the IMF as well as by BNP Paribas Economists, bearing in mind that growth may even miss these revised-down forecasts, we could face a downside trajectory to every month’s releases in the medium-term. This would imply that Chinese risk assets could potentially face further downturns in the first two weeks of every month, as is the case in the next fortnight. Have Chinese risk assets declined enough not to hurt global risk assets anymore?
Chart 1 shows that the Shanghai Composite has dropped quite sharply from the bull market boom, but it must be remembered that they are still well above the 2014 levels, before the significant rally from late-2014 to mid-2015. A better gauge would be to look at the Forward P/E ratio. Clearly this has corrected over the past few months, but at 11, it is still well above the average of 8 which it sustained for 3-4 years before all the exuberance.
Another fact that investors can gauge from Chart 1 is that the P/E ratio and the Index price more or less track each other. That means all the price gain was almost exclusively from multiple expansion rather than earnings growth! Assuming the same earnings, as shown by the experience before, the P/E ratio alone indicates another 30% of downside before Chinese stocks reach pre-exuberance level (late 2014). The point of this article is not to take a view on China, but to alert European Credit investors to the possible scale of potential headwinds. Given the surfeit of Chinese data coming up soon, we believe it is prudent to be stay cautious for the next fortnight
