The recent slowdown in China has had myriad impacts on global growth, currencies as well as on the collapse of the commodity and energy complexes.
These negative impacts could accelerate as Chinese authorities have just devalued the Yuan and seem unable to arrest the huge decline in the stock markets there.
Wouldn’t it be ironic that the “Black Swan” many have been expecting to disrupt the markets turns out instead to be “Red” in nature and came from China?
My regular readers on Seeking Alpha, Real Money Pro and Investors Alley know that I have myriad concerns both for the economy and equity markets, and have had them for several months. These include the strong dollar, the lack of any revenue and earnings growth in the S&P 500, current market valuations and the continued inability of Europe to do anything with Greece other than "kick the can" down the road continually in another last second deal.
However, my biggest concern for months has been around the situation in China. Even though authorities insist the country is growing at the 7% "official" GDP target, recent developments point to much slower growth. This has and will continue to have myriad and mostly negative impacts to the global economy and markets. Let's review the current situation in the Middle Kingdom.
Recent Developments in China:
Over the past few months, the Chinese have reported their worst industrial production figures in two years. In fact, both export and import growth were negative in July. These readings were one of the key drivers of the Chinese leadership's decision to devalue its currency, the Yuan last week. This provided a burst of volatility to global markets last week.
In addition, the authorities have taken extraordinary measures to halt a massive decline in their markets that started in the middle of June. None of these economic readings or actions by authorities support the case that growth is anywhere close to the official seven percent growth target. My own personal view is growth is probably around half that level right now.
China has accounted for a good portion of the marginal demand across the commodity and energy complexes for over a decade. The slowdown in the Middle Kingdom is the key reason commodities like copper, iron and coal are at multi-year lows and the Bloomberg Commodity Index is at levels not seen since 2002. China is also a key but not the only factor behind the yearlong slide in crude prices.
The collapse of commodity prices in turn has severely weakened the economies and currencies of commodity based countries like Australia, Canada and Brazil. This trend should continue and will be one of the main reasons global growth will come in at its lowest level in 2015 since 2009.
The recent decision by the Chinese to devalue the Yuan will exacerbate the developments above as well as have new ramifications for the global economy and markets. This is especially true in Asia. This is the last thing the export led economies of Korea or Japan need at the moment. Korea recently posted its worst quarterly growth levels in six years and data released yesterday showed the Land of the Rising Sun contracted in the second quarter.
I would also be concerned about the tertiary countries of Asia where this devaluation will put their economies and currencies under additional pressure. Malaysia racked by a corruption scandal and falling oil prices has seen the Ringgit fall by 23% against the dollar already over the past year. Thailand's Baht sank to its lowest levels since 2009. This is reminding some of the environment just before the Asian crisis in 1998. Expect the dollar to go through a new round of strengthening against the Asian currencies in coming quarters. This will mean additional currency hits to the revenues and earnings of the S&P 500.
The Unthinkable Scenario:
My biggest worry for the market is it doesn't seem to factor in whether this recent slowdown in China isn't a temporary event but the start of a larger trend. China is the second largest economy and market in the world. If suddenly, it went from the 10% annual growth the world has come to expect over the last 25 years of its economic transformation to something close to half those levels, obviously that would have negative consequences for everything from global growth, emerging markets, commodities and currencies.
The market seems to be sanguine that Chinese authorities will be able to halt the slide in their markets and economy. I am not so sure. Recent measures certainly did not stop Chinese equities from plunging an additional six percent overnight. In addition, if growth is permanently at a lower trajectory, China might have substantial trouble servicing the massive amount of debt the country has run up since the financial crisis.
I will continue to have my portfolio on a very cautious footing until it appears global growth particularly from China is improving. I will also continue to be severely underweight energy & commodity stocks in my portfolio, as I believe there will be more pain and myriad bankruptcies in these sectors before all is said and done. Currently, I am keeping a tad more than 30% of my overall portfolio in cash at the moment.
After all the worries around the huge amount of quantitative easing measures taken by the central banks of Europe, Japan and the United States as well as five years of drama from Greece and other periphery nations of Europe, wouldn't it be ironic that the "Black Swan" many have been expecting to disrupt the markets turns out instead to be "Red" in nature and came from China? Food for thought. Happy Hunting.