China as the new global bellwether, and why Netflix sell off could be good news for Europe

We mentioned yesterday that the markets seemed in good spirits, but we urged caution for a few reasons: firstly, the threat of Covid 19 has not gone away and is still a clear and present danger for the global economy, secondly, stocks have had a very strong recovery, particularly tech stocks, and lastly, Chinese stock markets had started to show signs of nervousness even though other Western markets were rising. 

Why traders should turn to Beijing for direction 

Looking at China first, we recently wrote about the strong rise in Chinese markets and how this could lead the way for European and US markets in the short to medium term. The sharp rise in Chinese stocks from the end of June to the 8thJuly was spectacular, a 500-point rally is worth watching closely. While there were signs that this rally was driven by state-media who urged retail traders to buy stocks, some of its enthusiasm did spread to the West where stocks followed suit with a decent run at the start of July, albeit the gains were moderate in comparison with China. Back then, we said that Chinese stock market optimism could spread to the West because of the power of the Chinese economy, and of the Chinese consumer, in particular. This could be a powerful driver of demand for Western companies as they recover from the coronavirus crisis. However, as China’s shares become an important bellwether for global sentiment (due to China’s economic power), when the Chinese stock market falls then it can drag US and European markets lower, as we saw on Thursday. 

China’s lacklustre economic recovery 

Although China’s economy has started growing again as it recovers from the effects of the pandemic, there were some parts of the Q2 GDP report that caused concern. China may have grown by 3.2% in Q2, but fixed asset investment fell by 3.1% and retail sales for June were down by 1.8%. The bulk of growth was thanks to the industrial sector, which saw growth of 4.8% June on an annual basis. This is fuelling worries that China’s economic recovery is driven by the state-backed industrial sector, and not the consumer. Thus, the economic recovery in China may not be that good for European and US companies after all. China’s Shanghai Composite Exchange fell by a whopping 5%, the largest decline since February, while European stocks were down roughly 0.5%. There could be further declines for global stocks at the end of this week after Netflix missed earnings estimates and the shares fell sharply on Thursday night. 

All Netflixed out…

Netflix is the first of the major tech titans, or Fangs, to report Q2 earnings, however, it wasn’t the glowing report that some of the analysts had expected. Netflix shares fell approx. 12% late on Thursday night, after weaker than expected earnings per share, while its guidance for Q3 was also disappointing. Revenue did beat expectations for Q2, at $6.15 bn, beating expectations of $6.08bn, subscriber growth was also a whopping 10.09 million for Q2, beating the 8.26mn expected. However, this is old news, the share price decline is mostly down to the Q3 guidance, which saw weaker projections for revenue ($6.33bn, below the $6.40bn expected), and subscriber growth is expected to rise by 2.5mn, significantly weaker than the 5.27 mn expected. 

TikTok: the new kid in town

Netflix management said the significantly weaker pace of growth was down to the ending of lockdown restrictions around the world, and also due to the phenomenal growth of TikTok, which highlights the “fluidity of internet entertainment”. While people my age (wrong end of the 30’s), may not even consider TikTok entertainment, especially when compared to sitting down to a good TV series on Netflix, the younger generations are starting to choose free TikTok content and short form videos over subscription streaming services. TikTok will be a tough competitor for Netflix in the coming years, and unless the streaming giant can find a way to attract younger subscribers then lower growth might be a feature of the future, and a good example of the fickle nature of the tech sector. It could also mean a lower stock price for some time, and a longer recovery time back to the record highs reached earlier this week. 

On the upside, Netflix: still king of the streaming service 

Overall, compared to other subscription services Netflix continues to do well. Apple TV, Disney + and HBO’s new streaming service didn’t dent Netflix’s earnings and subscriber growth in Q2, and it is interesting that Netflix management singles out TikTok rather than its streaming rivals as major threats for the future. In its space, Netflix is still a strong contender. To further assert its position, the earnings report also said that Netflix’s slew of original content for 2021 will not be impacted by the shutdowns caused by the pandemic. 

A strong ledger of future content releases is positive for the company; however, the market doesn’t seem to care too much. The weak future guidance for the report, and the sharp decline in Netflix’s stock price could set the tone for trading on Friday, with the Nasdaq at risk of a weak finish to the week as investors fret that other Fangs could see a similar drop in demand in the third quarter.  Interestingly, if Netflix triggers a sell-off in the US tech sector, which has been a possibility in recent weeks, then it could drive inflows into European stocks that have less exposure to the tech giants. This could be good news for the FTSE 100, which may benefit from rising oil prices, and also European indices like the Dax that are more exposed to the industrial sector.