Problems in China Are Driving Market Volatility

Problems in China Drive Market Volatility

The market volatility that we’re seeing comes down to the outlook for China. There are two main points to keep in mind.

Economic Slowdown: The first is that China is facing extraordinary pressures. It's at the end of a cyclical boom, where it built up too much excess capacity, and too much credit. And it is trying to digest that at the same time it's trying to maintain economic stability. It is a very challenging environment with a downshift in growth in China.

Currency and Interest Rate Squeeze: The second thing is that China is also being squeezed by the increase in interest rates that the Federal Reserve started to initiate in the U.S. China had kept their exchange rate pegged to the U.S. dollar for quite some time. But it is very difficult to control both your exchange rate and your interest rate. So, as the Federal Reserve moved to tighten, that strengthened the dollar, which in turn strengthened China's currency. It created a tightening in the Chinese system that made it very, very hard for them to ease monetary policy.

So, we're seeing a culmination of both China's economic weakness, as well as, its efforts to try to ease its currency policy. This has really made the markets much more volatile in 2016.

What May Be Ahead

Our outlook is that it is going to continue to be a very volatile backdrop for China, as well as the global financial markets. Over the course of 2016, policymakers in China are going to continue to pour fiscal and monetary stimulus as well as some currency easing into the picture, which should eventually stabilize things in China. It should help stabilize the global environment and perhaps even financial markets as well.

It's quite likely we can continue to see some volatility in the financial markets in the short term, so it is very important to remember your long-term investing objectives.

Chart of The Day: World Market Performance, Post-Financial Crisis

Chart Courtesy of Chart of The Day

For some perspective on the post-financial crisis rally, today's chart illustrates how much of the downturn that occurred as a result of the financial crisis has been retraced by several major international stock market indices.

For example, the S&P 500 peaked at 1,565 back in October 9, 2007 and troughed at 677 back on March 9, 2009. A recent close for the S&P 500 was in the 1,848 neighborhood -- a retracement of +132% of its financial crisis bear market decline.

As today's chart illustrates, China (Shanghai Composite), Japan (Nikkei 225), India (S&P BSE Sensex), Germany (DAX), France (CAC 40) and the U.K. (FTSE 100) are all above their financial crisis lows (i.e. above 0% on today's chart) and three of the aforementioned countries (Germany, India and the U.K.) are currently trading above their respective pre-financial crisis peak (i.e. are above +100% on today's chart).

It is interesting to note that the U.S. (epicenter of the financial crisis) has outperformed the other major stock market indices (* keep in mind that the German DAX is unique in that it includes for the reinvestment of dividends) while China has lagged to the point where it only trades +9.3% above its financial crisis lows -- not that impressive of a performance considering that the financial crisis occurred well over four years ago.


Chart Courtesy of Chart of The Day

Recession in the USA? Depends On The Global Economy's Big Three...

Turmoil Dampens Already Slowing Global Economy

The eurozone sovereign debt crisis has contributed to rising risk aversion in global credit markets. Even more fundamentally, the crisis has reinforced the increasingly weak outlook for European economic growth. 

Europe accounts for roughly one-fifth of the global economy. 

Weaker European demand will likely further damage already decelerating export growth in Asia and other regions.

China’s economy has moderated substantially in recent months amid significant monetary tightening. A slowdown in exports raises the near-term risks of a hard landing there. 

Japan has been unable to fully regain its footing after its nuclear and natural disasters.

With Europe, China, and Japan accounting for 50% of non-U.S. economic activity, the world’s three largest economies outside the U.S. may be stalling.

Coal, Not Oil Dominates China's Energy Consumption...

Coal powers the Chinese economy.

The country is the world’s largest coal consumer, gobbling up nearly 50% of the world’s coal consumption in 2009.

Coal accounted for 71% of China’s energy in 2008—more than 3 times the United States’ share. By contrast, oil accounts for only 19% of China's total energy consumption

The Electricity Council estimates that the country’s coal demand will reach 1.92 billion tons in 2011, up nearly +10% from 2010.

China hasn’t always been such a glutton for coal. In fact, coal consumption actually declined from 1996 to 2000. However, consumption has shot up +180% since then and China accounted for 80% of demand growth between 1990 and 2010.

This is because demand for electricity exploded over that time.

China’s rapid urbanization and rising middle class has led to an exponential number of new refrigerators, air conditioners and other appliances in homes. China sits atop the third-largest store of recoverable coal reserves, behind the U.S. and Russia.

Impressive Facts About China's Growth...

1. China will become the 2nd largest consumer market in the world by 2015, behind only the U.S. 

2. Wal-Mart is opening one store per week in China. 

3. KFC is opening one store per day in China.

4. IKEA has stopped advertising in China because its stores have become so crowded it's facing "crowd control" problems.  

 ~James McGregor, author of the book "One Billion Customers: Lessons from the Front Lines of Doing Business in China," from his interview on NPR.

One Reason for High Oil Prices: Chinese Demand

China’s oil consumption per capita has increased over +350% since the early 1980s until now.

In fact, consumption per capita has risen nearly +100% in just the past decade!

A Millionaire Boom Is Coming...

Despite the Great Recession, which wiped out $15.5 trillion in household wealth in the United States alone, the number of millionaires in this country and abroad will grow rapidly over the next decade.

In the U.S., the total number of families with a net worth of over $1 million, including real estate, will double by 2020, according to a report by the Deloitte Center for Financial Services.

Overall, the U.S. and Europe have the greatest concentrations of wealth than any other region, although emerging markets are narrowing the gap.

China will lead the way in millionaire growth, the report said, followed by Brazil and Russia. By 2020, China and South Korea will rank in the top 10 of countries with the greatest total number of families worth more than a million dollars.
"There is going to be very fast growth, but it will take a lot longer to reach anything like the wealth in the developed world," said Andrew Freeman, lead author of the report.

With 10.5 million, the U.S. has -- by far -- the greatest number of millionaire households in the world, despite the financial crisis and ensuing recession which knocked more than 3 million millionaire families off the map between 2006 and 2008.

The number of millionaire households is expected to return to pre-crisis levels by 2015 and reach 20.6 million in 2020, maintaining the U.S.'s position in the top spot. By then, 43% of the world's wealth held by millionaire households will be in the U.S., up slightly from 42% this year, the report said.

Japan is expected to rank a distant 2nd, with 8.6 million millionaire households in 2020 and 9% of the world's wealth. China is expected to be No. 7, with 2.5 million millionaire households in 2020 and 4% of the world's wealth.

How U.S. Oil Consumption Compares to China's...

The U.S. consumes +21.7% of the world's daily oil production, more than double the +10.4% consumed by China. 

The USA's population is 311 million.  China's population is 1.319 billion or 1 billion greater than the USA.

Source: British Petroleum

 

Chart of The Day: U.S. Exports to China Are Soaring

The conventional wisdom that China doesn't buy anything from America is a fairy tail!

Which begs the question:

"What kind of shape would the U.S. economy and U.S. employment be in if the emerging markets weren't buying our goods, services and technologies during the past 10 years?"

China's Per Person GDP is Woeful...

China just surpassed Japan as the #2 country in the world in total Gross Domestic Product (GDP).

But after adjusting for GDP (Purchasing Power Parity) on a per-capita basis, China (at $6,567 per person) has a long way to go before it achieves "Superpower" status, considering that it ranks #102 according to the CIA, #99 according to the IMF, and #92 according to the World Bank.

In fact, on a per-capita basis in 2009, China ranked behind Namibia, Jamaica, Belize, Thailand, El Salvador, and Albania.

U.S. per-capita GDP currently stands at $46,400, or more than 7 times that of China.

U.S. household income currently is in the $50,0o0 neighborhood, or more than 20 times that of China, whose household income is roughly $2,500 per year.

And the last time the U.S. had per-capita GDP of $6,567 was back in 1932.

Country P/E Ratios and GDP Growth

Many investors use the PEG Ratio as a valuation tool these days because it puts a company's growth prospects into perspective along with the widely followed price to earnings ratio. The PEG ratio is the P/E Ratio over the Growth Rate, and a PEG of less than one is generally considered good.

In this regard, Bespoke created "PEG" ratios for a number of countries using the P/E ratio of each country's main equity market index along with 2010 estimated GDP growth rates. Just as with stocks, the lower the country PEG, the more attractive.

As shown, India has the best PEG out of the countries we analyzed. It has a P/E ratio of 26.19 and estimated 2010 GDP growth of 8%. While its P/E isn't as low as a lot of countries, its growth rate is very high. China ranks 2nd with a PEG of 3.66.

The U.S. ranks in the middle of the pack with a P/E of 24.53 and estimated GDP growth of 2.6%.

At the bottom of the list sits Switzerland, Italy, and the UK, while Australia, Japan, and Spain have negative PEGs due to either a negative P/E Ratio or negative estimated GDP growth.

Chart and analysis courtesy of Bespoke Investment Group