Europe profits from China's recovery

SHI YU/CHINA DAILY

China's importance for Germany has grown over the years. The European Union's exports to China are much larger than the United States' exports to China, both in absolute and relative terms. Within the EU, Germany makes up almost half of the EU's exports to China. Germany's export exposure to China is about two times higher than the EU's average when compared by GDP and almost five times higher than the US' (according to 2022 data).

The EU economy is even more dependent on China when it comes to imports. In 2022, imports from China accounted for 4 percent of the EU's GDP, while only 2 percent of US imports came from China.

Business with China contributed about 15 percent to DAX 40 companies' earnings and 9 percent to EURO STOXX 50 companies'. Germany's auto industry, in particular, depends on Chinese exports (25 percent earnings exposure), with the semiconductor and chemicals industries relying heavily on business with China as well.

While auto and luxury are the most exposed sectors in the sample, we expect our preferred sectors — travel and leisure, chemicals and basic resources — to benefit most from China's economic recovery.

Chemicals are among the top traded goods between the EU and China and represented about 8 percent of the EU's exports to China last year. Analysts have revised down earnings estimates for the sector despite growing demand from China and falling energy costs. We reiterate our overweight stance.

China accounts for about 15 percent of earnings from DAX and EURO STOXX 50 chemicals companies.

The Bloomberg Industrial Metals Index is up about 11 percent since October 2022, but remains below its March 2022 peak. So improving demand from Chinese manufacturing, renewable energy projects and the property sector should stimulate the demand for metals, with lower energy prices and low leverage levels providing additional support to the sector.

We (Deutsche Bank) expect a strong rebound in tourism demand from China as household savings have accumulated during the COVID-19 pandemic and Chinese travelers are willing to spend more on tourism services. As a result, the EU should benefit strongly from Chinese tourism demand: before the pandemic, Chinese tourists accounted for 10 percent of non-European travelers to the EU and spent almost €10 billion ($10.92 billion) on trips to the EU in 2019.

The manufacturing and services sectors recovered simultaneously, and both are showing strong growth (with purchasing managers index around 10-year highs). And positive signs are emerging from the property sector, reflected by stronger sales and higher prices.

From an earnings perspective, the stronger-than-expected growth in China is partially compensating weak growth in Europe. Consensus first quarter 2023 earnings estimates for the STOXX Europe 600 have been revised down to-5 percent (year-on-year). Earnings estimates now look more realistic, and they should allow for positive surprises in the upcoming reporting season.

Also, the services sector is recovering slightly faster than the manufacturing sector, and travel and dining services are particularly strong. At the same time, there is no decline in goods spending. In fact, Chinese consumers are spending more on clothing, jewelry and even furniture. The only sector showing weakness is consumer durables, especially cars and mobile phones.

Given that the economic recovery has just begun, consumer confidence might not yet be high enough for consumers to spend their money on durable goods, and while automobile is the sector with the strongest earnings exposure to China, we currently do not see a strong positive impulse on earnings.

Domestic travel is only the first step of the recovery. Given that international travel will require much more planning ahead, and considering that airlines still need to build up capacity, we still need some patience for international travel to return to the pre-pandemic level.

Besides, the first evidence from Hong Kong is showing a strong inflow of Chinese mainland travelers, while travel to the rest of Asia and Europe/the United States should also begin rebounding soon and hopefully normalizing by the second half of this year or by early 2024.

We reiterate our overweight in travel and leisure. Lower energy costs, limited capacity and high post-pandemic demand from Europe and the US have already provided tailwinds to the sector. After three years of travel restrictions in China, and a 20 trillion yuan ($2.90 trillion) increase in household deposits, we expect a strong push for demand.

Furthermore, investment in renewable energy is one of the government's priorities for the medium to long term (with the goal to realize carbon neutrality before 2060). Investments in the energy generation and supply sectors increased by 30 percent year-on-year in 2022, with more than 40 percent of new power generation capacity coming from solar, and 20 percent from wind energy.

We reiterate our overweight in metals and mining due to low leverage, lower energy costs and growing demand from China, and we have recently increased our copper price forecast.

Wage growth has been subdued over the last few years, and it will still take some time for labor markets to tighten again. In addition, China has been largely sheltered from higher energy prices, as the country does not rely much on natural gas and crude oil, instead using coal as the major energy source, even though the majority of new power supply is coming from renewables.

With the reopening of the Chinese economy, inflation could pick up slightly in the second half, potentially approaching 3 percent. However, we expect core inflation to remain moderate, and overall, inflation to not be a big concern for the Chinese economy. The People's Bank of China's current focus is on economic growth, and as such, there is no real need to tighten monetary or fiscal policy. And we do not expect a change in the monetary policy rate.

Xiong Yi is chief China economist, and Maximilian Uleer is head of European Equities and Cross-Asset Strategy at Deutsche Bank.