Expect years of pain for China-exposed European stocks
We are surprised there has been such a sudden change in the view of the Chinese economic outlook. All the work we do is out on the road visiting companies and we have been acutely aware of the slowdown. This is a slowdown that has been progressing for two years.
We made the bold decision at the end of 2012 and beginning of 2013 to sell pretty much anything China-dependent. We felt the consensus numbers were way too optimistic right across the economy – whether it was the luxury goods companies or the metals and mining businesses. As a result, we have been unusually domestically-orientated over the last few years. Any non-domestic stocks we hold are international companies not dependent on a growing wealth in China.
For small cap companies, a common theme for the last three years is that companies are finding they cannot do business in China. Sure, this would have held them back on the way up, but it has really protected these companies on the way down amid the recent volatility.
We can see the [European] recovery really beginning to gather momentum on the ground. The most tangible sign can be seen in the second quarter numbers, with a strong number of companies beating consensus.
The real surprise has been the banks: BNP Paribas, Intesa Sanpaolo and Commerzbank each generated numbers well in excess of expectations.
The macro figures are also consistent with this recovery. Clearly the hotspots are in the periphery, excluding Greece, with Spain growing at around 3% for example. The core countries are starting to recover as well.
This is quite controversial, but our view is that this de-rating for China-exposed stocks is going to last another three to five years. These companies, the likes of Diageo or L’Oréal, are still way too expensive. Analysts still have not understood how fast the Chinese economy is slowing down.
Stuart Mitchell (pictured) and Jamie Carter are managers at S. W. Mitchell Capital