We ring in 2016 with a good dose of market volatility. The five year graph of the Shanghai Composite Index shows a bit of a decline in 2011, fairly flat in 2013 through mid-2014, and then a steep rise starting in mid-2014. This rise coincided with the Chinese government encouraging citizens to buy stocks, even as monthly economic statistics were showing the economy was slowing and economic data was coming in below forecasts. Unlike the United States and Europe where pension funds, university endowments and mutual funds make up a large portion of stock ownership. China is almost all affluent, individual investors. Given this dynamic greater volatility is almost a given.
In the latter part of the 1990s corporations were moving manufacturing to China from the United States and other countries to take advantage of lower labor costs. This mass influx of manufacturing drove the Chinese economy for the last 15 years, resulting in annual GDP growth of 8-10%. This is an almost unheard of figure, and one that eventually has to moderate. Growth in the Chinese middle class has been fairly rapid and consumer spending will be a larger portion of their economy going forward. The Chinese government is trying to transition from primarily a manufacturing and exporting economy to be more of a consumer based economy.
Currency – We continue to see China’s currency (Yuan) be devalued against the U.S. Dollar and Euro. Although currency instability has rattled markets, it does have a positive impact on U.S. corporations purchasing Chinese products. Walmart specifically should be a big beneficiary, as a weakening Yuan reduces the costs of Walmart’s extensive purchases from China.
Markets – The Chinese government has looked somewhat clumsy in their actions in dealing with a slowing economy and a stock market that had a huge one year run up from mid-2014 through mid-2015. They imposed a circuit breaker to shut down the stock market if it dropped by 5%. It took 29 minutes to reach that point during one day this week. The government has now withdrawn that rule. In addition, most of the individual investors within the Chinese market are also Chinese citizens. Their market rules make entry of foreign money difficult to say the least. This has created a situation in which large numbers of persons relatively new to stock market investing have driven up market prices to unsustainable levels. We are seeing a drop in price as the President, Xi Jinping, has begun to change the government’s oversight of the markets. These are long-term oriented reforms that are painful in the short-term, but should give better results than the patchwork stimulus implemented over the past summer.
While the volatility in the Chinese stock markets is attention grabbing, it likely would not impact the average investor elsewhere. You may recall stories in the 1980’s about Japan’s rapidly growing economy. Their economy was growing by leaps and bounds until 1989. Their market peaked in that year and has never fully recovered. Most U.S. companies and households did not notice this slowdown in the 1990’s even though Japan was a U.S. economic partner. China is 0.7%1 of the U.S. export market. A slowdown in the Chinese economy is likely not going to be felt in the broad U.S. economy. It is simply not large enough to be felt.
United States Economy
Employment – December employment figures released today show a gain of 292,000 jobs. This beat a consensus estimate of 200,000 jobs. The employment figures for October and November were both revised upward by 50,000. Almost all sectors of the economy posted job growth except energy. The unemployment rate remained steady at 5%.2
Corporate Earnings – Corporate profits are the life blood of stocks. GDP projections are holding steady at low, but positive numbers. Some sectors are seeing typical cyclical contraction, but a company that made money in 2015 is likely to continue to make money in 2016. I would guess the year over year growth in 2016 will be a bit lower than recent years but still growing.
Starting the middle of January we will start to see the release of 4th quarter corporate earnings results. These results should help support the markets. In manufacturing employment gains in chemical and plastics are offsetting job losses in metals and energy. Retail sales show a migration of consumers to online firms over traditional brick and mortar retail.
Construction – Construction continues to hold up well in both commercial and residential. New home starts for November rose 10.45% from October and 16.48% since one year ago.3 US existing home median sales prices are up 6.32% over the one year period.4 Housing is no longer a drag on the overall economy, but rather a healthy sector contributing to overall growth.
Bright spots in the market in 2015 were technology companies, including biotech. Several companies have interesting new drugs, devices, or other technology based products that are likely to help company earnings. REITs are another area to watch. REITs tend to perform well in rising interest rate environments. We’ve seen some healthcare REITs whose valuations have dropped far enough during the past year that early 2016 is an attractive entry point in these offerings. Overall, the U.S. economy is in good shape. The market activity in China is interesting to follow, but will not have a material impact on the economy here.
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