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More Easing Ahead
More Easing Ahead. Following the weakening of a number of key economic indicators in August, we believe that China’s government will step up its stimulus policies in the coming weeks and months.
The People’s Bank of China last week pumped 500bn yuan of liquidity into banks and cut the 14-day repo rate following the release of poor August economic data.
While structural reforms will continue and balanced growth remains a key priority, we believe targeted stimulus will be accelerated to ensure growth meets the government’s 7-8% target.
A gradual ratcheting up of targeted monetary and fiscal stimulus, together with expected increased inflows into domestic A-shares as the Shanghai-Hong Kong Stock Connect program goes into effect in mid-October should support the continued strong performance of A shares as we move into Q4 2014 and beyond.
He who treads softly goes far
Disappointing data reported over the past month is likely to serve as a catalyst for further policy stimulus in the next few months in our view. While toeing the official line that reform takes precedence over everything else, Premier Li Keqiang has also reminded local governments of their “inescapable responsibility” to meet growth targets. Keen not to be perceived as going back to the ‘old China’ ways of pursuing growth for growth’s sake, the stimulus is likely to remain more subtle than the CNY 4trn ‘bazooka’ used in 2008. At the same time, the government has the capacity and policy conviction to see that the growth target of 7-8% is met.
While there have been no broad-brush cuts in reserve requirement ratios or lending rates since 2012, the government and the central bank have been actively easing policy since April (see table below).
A large part of the stimulus since April has been delivered by the central bank, the People’s Bank of China (PBoC). The PBoC has the capacity to act quickly – as we saw last week – and can separate itself from some of the Central Government’s reform initiatives.
The table below is far from exhaustive, with local governments in particular having undertaken a number of stimulus activities of their own. However, with the probe into corruption, local governments have been unusually reticent, shying away from highlighting their activities. Nevertheless, policy adjustments to house purchase restrictions for example are likely to go a long way to helping the slowing housing sector see new sources of demand.
The case for more easing
The absence of inflation constraints
The PBoC has substantial capacity to stimulate the economy without raising inflation anywhere near its target of 3.5%. In August inflation slipped to 2.0% from 2.3% in July. Indeed if it is serious about the target, it will need to stimulate demand as it is unlikely that a significant supply-side shock is going to raise inflation to 3.5% in the near-term.
Compensating for shadow-bank deleveraging
While most shadow-banking activities sit within the oversight of the China Banking Regulatory Commission, a small portion does not. Fears of excessive credit growth in the shadow-banking sector has led to pull-back in trust loans (lending by non-bank, deposit taking institutions). Additionally loans that have been taken off balance-sheet by banks (by “undiscounting” bankers’ acceptances) are increasingly being kept on balance sheet. With the onus of credit intermediation falling back on formal banks and with loans remaining on their balance sheet, the PBoC needs to help State banks free-up lending capacity so that credit can be directed to the real economy.
Shadow banks lend and pay depositors on commercial terms, in contrast to many state banks. They arguably direct credit to growing sectors of the economy more efficiently than state banks. If this period of shadow bank deleveraging/banking renaissance continues, loan growth may have to increase more substantially to get credit into the right parts of the economy. The PBoC’s encouragement would therefore be necessary to facilitate this process.
Export growth alone is not enough
Export growth has been surprising strong, while import growth has been relatively muted. While that will help boost GDP figures for the quarter, it is not guaranteed to continue indefinitely.
Indeed with the renminbi appreciating against the dollar, which in turn is appreciating against most other currencies, Chinese exports are getting more expensive for recipient countries
Also lower import growth in China, could hurt demand for Chinese exports from its partner countries, creating a negative feed-back loop.
With China seeking to rebalance its economy away from being an exporter of goods lower down the value chain, the need to stimulate internal demand is clear.
Property markets need micro-targeted policy assistance
As discussed in the August China Macro Monitor, while developers have displayed some cautious optimism by increasing building activity, demand is currently weak as many potential buyers are taking a ‘wait-and-see’ approach. So while captive demand exists with urbanisation continuing unabated, a lack of confidence could contribute to a downward spiral in demand. A decisive policy shock could break this mind-set and avoid the build-up of excess housing. Given that housing supply-demand balances vary widely across provinces and cities, the policy moves will likely have to be carefully targeted with local governments taking the lead in implementation.
China A-Shares continues to rise
Over the past month, the China A-share index has continued to increase, although the soft economic data has capped its gains.
The successful completion of a practice session last weekend will likely see the Shanghai-Hong Kong Stock Connect go live in mid-October as planned. We believe that the Connect initiative will allow better arbitrage between the Hong Kong and Shanghai exchanges, narrowing the current premium Hong Kong stocks have over those trading on the mainland (see Shanghai-Hong Kong Stock Connect: A Boost For China A Shares). A-share discounts to H-shares have been steadily narrowing over the past two months, but still stand at 4%.
The application of quotas favours flows to the mainland over outflows to H-Shares in Hong Kong and will increase the number of investors in the China A-share market.
The Connect does not however link up the Shenzhen exchange to Hong Kong and therefore broad China A indices (which track stocks on both the Shanghai and Shenzhen exchanges) offer investors a compelling alternative to buying stocks directly
Investors have additionally benefited from yuan appreciation, with the China A Share index priced in US dollars.
While most economic data last month was disappointing, the flash release of HSBC/Markit’s purchasing manager indices for September came in as a positive surprise, indicating a potential increase in industrial activity is on its way. Domestic equity markets reacted positively to the news.
We anticipate as government and central bank easing gradually ratchet up in the coming weeks and months, and foreign investors increasingly focus on the extremely beaten down valuation of the A-shares market relative to major developed equity benchmarks and their own history, that A-Shares will continue to outperform.
Important Information
This communication has been provided by ETF Securities (UK) Limited (”ETFS UK”) which is authorised and regulated by the United Kingdom Financial Conduct Authority (the ”FCA”).
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The race to bolster European defence capabilities is well underway. Since the invasion of Ukraine, European leaders have intensified calls for increased defence spending. The continent, long reliant on US security guarantees, is now facing a critical inflection point. Recent moves by the US administration to engage with Russia without consulting its European allies or Ukraine have underscored the urgent need for Europe to take charge of its own defence. This geopolitical reality has forced European leaders to acknowledge that relying on US support is no longer a guaranteed strategy, accelerating discussions on independent military capabilities and funding mechanisms.
Why is European defence spending rising?
For decades, the US has outspent Europe on defence, contributing more than two-thirds of NATO’s[1] overall budget. However, NATO estimates that in 2024, 23 out of 32 members met the 2% GDP[2] defence spending target, compared to just seven members in 2022 and three in 2014[3]. More ambitious goals are being discussed. Poland is leading the way with a 4.12% of GDP defence budget, while discussions at NATO suggest some countries may need to increase spending to 3% or higher1.
Figure 1: NATO allies defence spending following Russia’s invasion of Ukraine
Source: Atlantic Council, WisdomTree. 2024 numbers are estimates. Iceland excluded as it does not have a standing army. Historical performance is not an indication of future performance and any investments may go down in value.
Adding another layer of complexity is the US Department of Government Efficiency (DOGE) initiative, which is beginning to reshape US defence priorities. The shift from cost-plus to fixed-price contracts under DOGE is putting financial pressure on defence companies most exposed to the US, which may see constraints on long-term spending commitments. This could have two contrasting effects: while it may limit US capability to fund European defence through NATO, it could also drive European nations to increase domestic procurement and reduce dependency on US defence systems.
Additionally, emerging security threats, including cyber warfare, artificial intelligence (AI)-driven military technology, and the growing presence of authoritarian regimes, have reinforced the need for increased defence investments. Europe’s reliance on outdated Cold War-era military equipment is another critical factor, pushing leaders to modernise their arsenals.
How will Europe fund its defence expansion?
Ramping up defence spending is a monumental task, especially given high sovereign debt levels across Europe. Yet, leaders are exploring creative solutions to secure the necessary funding. One approach is to reallocate existing European Union (EU) budgets, with discussions centring on repurposing unspent Cohesion Funds and Recovery and Resilience Facility (RRF) loans. However, legal restrictions within EU treaties may limit their direct application to military expenditures.
Another potential route is the issuance of European Defence Bonds, mirroring the successful NextGenerationEU pandemic recovery fund. By pooling resources at the EU level, this could offer a coordinated and cost-effective funding mechanism.
At the same time, private investment and public-private partnerships are gaining traction. Defence contractors and institutional investors are increasingly seen as strategic partners in financing large-scale projects, particularly in weapons systems, cyber defence, and artificial intelligence. Governments may leverage these collaborations to accelerate procurement and technological advancements.
Despite these options, one thing is clear—Europe must find a sustainable funding model to support its defence ambitions without derailing economic stability. Whether through EU-level financing, national budget reallocations, or private-sector involvement, securing long-term defence investment will be paramount in ensuring Europe’s security and strategic autonomy.
Impact on defence stocks: can the strong run continue?
European defence stocks have had a strong run since 2022, driven by surging order books, government contracts, and the realisation that military spending is no longer optional. Over the past year, Europe defence stocks rose 40.8%, outpacing broader European equities (+11.4%)[4]. Defence stocks trade at a historical P/E[5] ratio of ~14x, slightly above the long-term average, though still below peak multiples[6]
There are three key trends fuelling defence stock momentum:
• Backlogs at record highs: European defence contractors are sitting on unprecedented order books, with consensus forecasting 2024-29 CAGRs[7] of ~11% for sales and ~16% for both adjusted EBIT[8] and adjusted EPS[9]. These growth rates compare to just 8%, 11% and 12%, respectively, for the 2019-24 period[10].
Figure 2: European defence sector growth forecast
Source: Company Data, Visible Alpha Consensus, WisdomTree as of 31 January 2025. Forecasts are not an indicator of future performance and any investments are subject to risks and uncertainties.
• Government commitments: with long-term contracts locked in and additional spending likely, demand visibility remains strong.
• EU’s push for strategic autonomy: The European Commission has proposed a European Defence Industrial Strategy (EDIS), aimed at spending at least 50% of procurement budgets within the EU by 2030 and 60% by 2035[11].
Conclusion: a new era for European defence
The European defence sector is entering a new era of investment and strategic autonomy. With rising geopolitical risks and uncertainty over US support, European nations are taking proactive steps to build a more robust and self-sufficient military ecosystem. While funding challenges persist, the momentum behind higher budgets, technological investments, and NATO commitments makes this shift not just necessary, but inevitable.
With the EU backing structural shifts in procurement, defence stocks remain well-positioned, particularly those with exposure to land (for example, ammunition, vehicles) and air (for example, air defence, missiles, drones) domains.
Aneeka Gupta, Director, Macroeconomic Research, WisdomTree
This material is prepared by WisdomTree and its affiliates and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date of production and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by WisdomTree, nor any affiliate, nor any of their officers, employees or agents. Reliance upon information in this material is at the sole discretion of the reader. Past performance is not a reliable indicator of future performance.
[1] NATO = The North Atlantic Treaty Organization (an intergovernmental transnational military alliance of 32 member states).
[2] GDP = gross domestic product.
[3] NATO 2023 Vilnius Summit Declaration.
[4] Bloomberg, Europe defence stocks are represented by the MSCI Europe Aerospace & Defence Index and European Equities represented by MSCI Europe Index.
[5] P/E = price-to-earnings.
[6] Bloomberg as of 31 January 2025.
[7] CAGR = compound annual growth rate.
[8] EBIT = earnings before interest and taxes.
[9] EPS = earnings per share.
[10] Company data, Visible Alpha Consensus, WisdomTree as of 31 January 2025.
[11] European Commission: Joint communication to the European Parliament, the Council as of August 2024.
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