There have been a number of corporate announcements during the current earnings season that have mentioned China and the impact its slowing growth trajectory could have on future profits. High-end fashion retailer Burberry was the latest victim. It’s share price is one of the of the worst performers in the FTSE 100 on Thursday after the retailer trimmed its 2016 revenue forecast because of concerns about a slowdown in Chinese consumer spending.
Chinese consumer demand for Burberry goods has already dropped, and although Q1 profit exceeded recent forecasts, the prospect of a further slowdown in this important market is weighing on the share price. In fact, Burberry’s share price reached a peak at around the same time that Chinese growth turned south back in February.
Since Burberry, along with other luxury goods makers, are sensitive to changes in Chinese demand, it is worth looking at them in some detail. Figure 1 shows the Burberry share price along with the Shanghai Composite Index (the domestic Chinese index), the chart has been normalised to show how close the relationship is between the two. As you can see, up until February the two moved closely together, after which they diverged, with the Shanghai Composite surging to its highest level since 2008 and Burberry dropping back to January lows. This tells us a few things:
- The Shanghai Comp does not have much of a link to Chinese economic growth.
- Burberry could be a better gauge of Chinese consumer sentiment compared with the domestic index.
- The Shanghai comp’s performance is a reflection of the loosening of trading rules in China rather than a gauge of positive economic sentiment towards the Asian powerhouse.
Thus, if you want to guess when the Chinese economy is ready to turn a corner, watch Burberry rather than the Shanghai Comp.
Burberry could also be a useful gauge to determine sentiment towards some sectors of the FTSE 100, especially miners and consumer discretionary, which have exposure to China. If Burberry continues to weaken on Chinese economic decline then we may see weakness elsewhere, for example in some of the large miners. If this continues then the FTSE 100 index may struggle to break fresh ground above the 7,100 record highs.