We’ve seen three weeks of extreme equity market volatility, much of which has been blamed on China as it is feared that slower growth there will derail U.S. growth. As it turns out, recent numbers on the U.S. domestic economy show notable strength and growth.
There were probably other really good reasons the market corrected by 11.2 percent (S&P 500 closing values Aug. 17 to Aug. 25), including market valuation levels and the fact that we had not had a “correction” (10 percent or more decline but less than 20 percent) in four years. Every doomsayer came out of the woodwork claiming this was the beginning of another major bear market, but the underlying economic facts lead to a very different conclusion. Since most of the publicly traded companies in the U.S. do the bulk of their business in the U.S., we should examine what the impact of a slowing Chinese economy would be on the U.S. economy. Here are some relevant facts:
- While China does have the second-largest economy in the world, its GDP has a low correlation to U.S. GDP. There is no doubt that China’s economy is slowing, and that the decline is more significant than the Chinese government will admit. But, as The Economist pointed out in their latest issue, a 5 percent growth in China’s GDP today is equivalent, in output terms, to the 14 percent expansion China posted in 2007.
- Despite the globalization of the last 20 years, the U.S. economy is still a relatively closed economy with exports accounting for about 13 percent of GDP — the lowest level, by a wide margin, of any developed nation.
- From the 1970s to 2010, the second-largest economy in the world was that of Japan. Yet during much of that period, especially after 1990, Japan’s economy went into and out of recession. That didn’t seem to bother U.S. equity markets.
- The Chinese are trying to move their economy from one dependent on heavy industry, exports and infrastructure building to one that is more consumer oriented, like the U.S.
- During the height of the equity selloff on Monday, August 24th, Tim Cook, Apple’s CEO, sent a note to CNBC’s Jim Cramer saying that Apple’s sales in China were “continuing to experience strong growth…” And other lifestyle companies like Ralph Lauren and Kate Spade also reported strong China sales.
- If China’s consumer base is growing, then Tim Cook’s statement and the positive results from the lifestyle companies are not inconsistent with a slowing heavy industry but growing consumer base in China.
Consider the following U.S. data:
- U.S. GDP (Q2: 3.7 percent, revised up from 2.3 percent) is growing faster than at nearly any other time since the recession ended.
- Auto sales continue at a pace exceeding 17 million units (annual rate); for context, the 17 million unit seasonally adjusted annual rate has occurred five times so far in 2015; it occurred twice in 2014, and you have to go all the way back to 2006 to again find this level of sales (twice in ’06).
- The service sector indexes are at or near record levels (the ISM Non-Manufacturing Index was 60.3 in July, and 59.0 in August).
- The manufacturing sector is showing slight expansion despite weak international demand for manufactured goods (ISM Manufacturing Index was 51.1 in August) and has shown expansion (above 50) throughout the period of China’s industrial slowdown.
- The August employment number was an apparently disappointing 173,000, but total employment was really very close to consensus. When the 44,000 upward revisions to June and July are included, the total change in the number employed was 217,000. This, and the unemployment rate of 5.1 percent, continued the streak of strong monthly employment gains that began in 2011 and accelerated in 2014.
The point of all of the above is to debunk the idea that a slowdown in China is a disaster for the U.S. economy. That doesn’t mean, however, that it should be back to business as usual. There is fallout from what is going on in China and the rest of the world; that fallout applies to selective industries and companies, but not to the whole market. As happens 100 percent of the time during panic selling, the baby is thrown out with the bathwater, and some stocks go to bargain basement prices.
As long as China is transforming, the picture of world trade flows will be changing and markets may be more volatile than usual. Unless you are an expert in the area of international consumer trends, you might want to avoid companies with such dependencies. For most investors, this means that a passive (index) strategy won’t do as well as active portfolio management where sectors (and even individual companies) are chosen. You want to avoid companies overly tied to the international economy or dependent on heavy industry and commodities. This means concentrating on sectors and companies that sell mostly in the U.S. or are service-oriented. Stay with U.S. companies in homebuilding, healthcare, financials, and consumer cyclical, or ask your financial adviser for help.
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.