Why China-dependent stocks will keep being surprising market winners

The UBS equity strategist Francois Trahan said stocks that get at least 5% of their revenue from China were outperforming shares of companies that are less linked to China.

Trahan said interest rates in China were falling, and there are signs its economy is poised to get stronger while financial conditions in the US and Europe get tighter.

He said China-linked stocks should continue to rise if the pattern holds, and an easing of trade tensions could make them even bigger winners.

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Maybe no one told them there's a trade war？

It's the last thing investors might expect to hear in a time of rising trade tensions, but stocks with more exposure to China are doing better than those without it. The UBS strategist Francois Trahan said the pattern was clear in the US and even stronger in Europe and Japan.

“If one did not know about the trade dispute taking place, you would not think anything was out of the ordinary,” he said, adding that there are signs the pattern will continue.

The global slowdown in manufacturing that's affecting the US and Germany hit China first, Trahan said, so interest rates there began falling a year and a half ago. That means financial conditions in China are getting looser today, and there are signs its economy will improve.

The situation will be magnified if the trade war ends, or even if tensions decrease, he said.

“The interest rate dynamic could make China the BIG winner of any resolution or even détente of the lingering trade issues in the months ahead,” Trahan wrote.

The opposite is true in the US and Europe, where financial conditions are still getting tighter and manufacturing is weakening. While the US Federal Reserve recently cut interest rates, it will take months before that starts to affect the broader economy.

“If the decline in China's interest rates over the past 18 months is going to sustain higher readings in the China PMI, then the outperformance of companies with high China exposure seen around the world could very well continue,” he wrote.

Trahan calls a company “China-sensitive” if it gets at least 5% of its revenue from China. That now describes a full 24% of the S&P 500 index, a minority that has grown dramatically since the early 2000s. The sectors that do the most business in China include technology and industrials.

“If China does become the region to emerge from the global slowdown first, then these companies should benefit from this pocket of strength relative to their peers,” he said.

The trade war can't be ignored in all of this. It could reinforce this pattern or change it dramatically if tariffs rise and the situations get worse.

Until there's a resolution, Trahan said investors should watch metals companies, miners, and capital-goods manufacturers closely. He wrote that those stocks would provide clues about the performance of China's economy. That could make them winners, something that normally wouldn't happen in a weakening global economy.

“In a 'normal' global slowdown we would be avoiding sectors like materials and industrials but the divergence in interest rates between China and the rest of the world in recent years might complicate leadership immensely,” he said.