Since China devalued its currency in late August, the capital markets have become volatile. The markets clearly fear that contagion from China’s weakening economy could somehow infect the U.S., a theme that has been way overdone. Market volatility wasn’t helped when the Fed irrationally delayed its long anticipated rate rise in mid-September.
Let’s first talk about China’s growth and its possible impact on the U.S. Over the past few years, China has moved to restructure its economy away from state owned enterprises, which have been characterized by high debt, and away from infrastructure-led growth. They have encouraged the growth of privately owned companies, which have significantly lower debt levels. China is attempting to lower its dependence on credit; it is attempting to deal with its excess manufacturing capacity; and it is moving toward some form of consumer capitalism.
Clearly China’s economic growth is slowing, but its economy is not crashing, as appears to be the much overdone Wall Street fear. Rapidly growing economies naturally slow down in percentage growth terms. The fact that China is growing at less than 7 percent has somehow scared investors, and, yes, even the Fed. But last year, China’s GDP grew nearly $1 trillion yuan – about 7 percent. This was more yuan than it grew in ’07, but because its economy was much smaller then, lower total yuan growth in 2007 still amounted to a 14 percent growth rate. Just think about how absurd the worry is that China is in a recession – their unemployment rate is 4 percent and retail sales are up 10.5 percent year over year!
Conclusion: Wall Street’s fixation on and worry over growth in China appears to be grossly overdone.
China’s Impact on the U.S.
China’s overall economic health is unlikely to stall the current U.S. economic expansion:
- U.S. exports account for only 12 percent of GDP, about $2.3 trillion – a lot of money. But it pales by a factor of 6.5 in comparison to the domestic demand of more than $15 trillion.
- U.S. corporations earn $391 billion of profits abroad, but the $1.7 trillion earned at home is 4.3 times greater.
- The export sector, which is influenced by troubled emerging market (EM) economies and slowing worldwide manufacturing growth, impacts 13.2 million American workers. But service sector employees, who are impervious to EM issues, China, or the strength of the dollar, number well over 100 million – larger by a factor of 7.6.
Conclusion: Like the ’97-’98 Asian crisis and recession or the stagnation of the then-second largest economy of Japan in the 90s, China’s slower growth rate will only have a minimal impact on the U.S.’s service oriented economy.
Outlook – Q4 and Beyond
The Fed has been preparing the capital markets for a rate increase for at least two years. By not pulling the trigger in September, the Fed continued the “uncertainty” that the markets so abhor. And, after the Fed’s non-decision, volatility ramped up again in the equity markets. Yet despite an unpredictable Fed and market participants overly fixated on China’s growth and inappropriately worried about contagion, the U.S. economy continues to hum along:
- New home sales are on an uptrend, now showing an annual rate of growth in excess of 500,000 units for four of the past five months (August data). During that period, housing starts have been at an annual rate of more than 1 million units.
- The unemployment rate sits at a six-year low (5.1 percent). U.S. employers are not laying off (new unemployment claims at generational lows) because they can’t find qualified applicants. Ask yourself, just how is it that a growth slowdown (not a recession) in China is going to impact that?
- Auto sales remain at or above the 17 million annual rate, a record level.
- The ISM non-manufacturing index is near its high water mark (60.3 in July and 59.0 in August). The ISM manufacturing index is weakening due to the strong dollar and slowing exports, but that index accounts for only one-ninth as much as the non-manufacturing index.
- U.S. consumers have the best balance sheets of the century, have low debt/income and debt/equity ratios, and have more ability to service their debt than at any time since the 70s. In addition, the equity in their homes is back to ’06 levels.
- Low and falling gas prices, while hurting the oil patch, are a huge boon to American consumers.
- Q2’s real GDP growth rate was just raised again from 3.7 percent to 3.9 percent, and Q4’s is expected to top the 3 percent number.
The U.S. equity market was due for a correction, as it hadn’t had one in four years. Perhaps market participants don’t remember how rapid and volatile such corrections always are. Once such a correction starts, the reasons uttered may not make sense, or may be overly exaggerated (i.e. China’s growth rate). Don’t forget that fear is a much more powerful emotion than greed and irrational behavior always occurs during these market phases (shoot first, ask questions later). So if you are convinced that the current market volatility is something more than the occasional but normal (often scary) correction, then you must not be looking at the fundamentals and must believe that “this time is truly different.”
Robert Barone, Ph.D., is an advisor representative of Concert Wealth Management, Inc. and an employee of Universal Value Advisors, a NV LLC. Advisory services are offered through Concert Wealth Management, Inc., a registered investment advisor. Robert is available to discuss client investment needs. Call him at (775) 284-7778.
Statistics and other information have been compiled from various sources. Universal Value Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information. A more detailed description of Concert Wealth Management, its management and practices is contained in its “Firm Brochure” (Form ADV, Part 2A) which may be obtained by contacting UVA at: 9222 Prototype Dr., Reno, NV 89521. Ph: (775) 284-7778.