What to do about China? The question facing many western advertisers

The Q3 results season is now picking up steam and we have already started to see companies report their numbers, including some of the agency groups such as Omnicom and Publicis, whose numbers – and comments – were generally well received.

?Overall, the results are probably more mixed than what we have seen in previous recent quarters. According to Factset, 79% of the S&P 500 companies reporting to last Friday (the 18th) had seen positive earnings surprises but 9 companies had lowered their full year earnings guidance as opposed to five that raised numbers. However, even at this early stage, one market is standing out where comments have been negative and that is China.

The alarm signal has been raised after luxury goods company LVMH published their Q3 revenues, which showed an unexpected drop in revenues of -3% vs expectations of a 1% gain. Lower growth in Japan was named as the decisive factor but the key underlying concern is China, with LVMH stating that consumer confidence in mainland China was back down to Covid levels. In fact, Asia sales ex-Japan, fell 16% Year on Year.? LVMH’s results has raised concerns over wider Chinese consumer sentiment, which is vital for many luxury goods companies. Unsurprisingly, most of the luxury goods sector sold off post-results.

There are two obvious questions here. The first is should we consider LVMH as typical of the outlook in China, given its focus in luxury goods. I think the answer, for now, is yes. P&G reported its quarterly numbers last week and missed with expectations, with China dragging down the numbers and the company stating that a recovery in China was still several quarters away. While Nestle, which reported its Q3 revenues last week, did say it had seen organic revenue growth of +2.5% in Greater China in the quarter, it did state that its pricing was down 1.5% and that reflected a general low price environment in the country. That would seem to give backing to the claim that China faces deflationary pressures, exacerbated by consumers who are not spending money because of concerns over the economic outlook.

The second is a more controversial one, namely should these effects be seen as temporary or the new norm. While, globally, the economic news has (generally) surprised on the upside over the past 12 months, in China it is the opposite. Many advertisers had hoped that 2023 would see a rebound in Chinese consumer spending as Covid restrictions were lifted. That did not happen and those hopes were then shifted into 2024. However, this year it also has not happened and perhaps one question to ask what will change the situation. The Chinese authorities’ $1+ trillion stimulus programme is the obvious answer but, with over 60% of Chinese total household wealth invested in property (versus under 40% for the United States), there is a question whether this will work if the property sector remains weak.

In turn, this is likely to lead to many Western advertisers rethinking their plans for China. I do not think this will happen short-term but I think it is more likely medium-term. If you can get growth in more established markets through a mixture of some volume and some pricing growth, and add in some efficiencies, then that delivers a decent, if not spectacular, growth story for many companies. It may be that, unless Chinese consumer spending turns around quickly, and especially in an environment where Donald Trump is re-elected President, many global advertisers decide that it is less hassle to drive growth in their more traditional markets.

As usual, this is not investment advice.