Corporate earnings are doing their part to sustain economic recovery and give stock valuations some upside potential. It should also be clear, however, that earnings alone are not enough to push stock prices higher.
We know that earnings have been driven by cost-cutting, corporate investment in technology and steady consumer spending. But at present, none of these catalysts has a lot of upside. Or, maybe it's more accurate to say that investors don't see these catalysts as having much upside.
Strong corporate spending is the result of pent up demand as corporations deferred spending plans during the recession. Cost-cutting made corporations lean and mean. But without an increase in demand, the effect on earnings growth will become limited.
Then there's consumer spending. The consumer has done well supporting economic growth in the U.S. And there's even some hope that spending could increase, if we project that a higher savings rate gets converted into spending at some point down the line.
Still, it's clear that the U.S. economy needs the labor market to improve. Anecdotal evidence that a pickup in hiring is around the corner, like CEO surveys and economist forecasts, are all fine and dandy, but it seems to me that investors won't be satisfied until a non-farm payroll number puts up a big upside surprise.
In the absence of good news on the employment front, it would benefit the individual investor to be on the lookout for other upside catalysts. Number One on my list is China.
After all, China just surpassed Japan to become the world's 2nd largest economy. And it might match U.S. GDP by 2020.
There should be no doubt that demand from China has a major influence on global economic growth. And the U.S. economy is probably more sensitive to China's economy than most individual investors believe. In fact, demand from China is part of the key to unlocking hiring in the U.S.
Chinese demand for semiconductors, computers and software has been a double-edged sword for U.S. companies. For Intel (Nasdaq:INTC) and IBM (NYSE:IBM), revenues from Asia and China are helping drive growth. But for companies like Dell (Nasdaq:DELL) and graphic chip maker Nvidia (Nasdaq:NVDA), sales to China are hurting growth.
Measures taken by China's government to slow its real estate market knocked steel and copper prices lower, and were a big reason behind all of the "double-dip" recession talk.
But now that inflation has slowed dramatically, real estate prices in China have come down, and the number of non-performing loans has dropped, many economists and strategists expect that China will ease up on its tightening policies.
Steel, copper and shipping prices have all recovered in recent weeks in anticipation of growing demand from China.
Unfortunately, no one is taking the potential for renewed demand from China as a good omen for the U.S. labor market. Here's an interesting chart that might help make the connection…
Many investors seem to think the trade balance with China is a one-way street. And it's true that the U.S. does more than its share of buying Chinese exports. But this chart shows clearly that U.S. exports to China can't be ignored.
The red circle on the above chart shows clearly that U.S. exports to China slowed dramatically in January of 2010. But now that China may be lifting growth restrictions, investors should be focused on whether U.S. exports to China are increasing. Because that could be a good indication that job growth is on the horizon.
Chinese stocks recently made their biggest move since February. Chinese stocks have been in a bear market for over a year. And yet, the recent move and very attractive valuations have not convinced investors to hate them any less.
I've said it recently and I'll say it again: it's a good time to pick up a Chinese stock or two.
I asked TradeMaster Daily Stock Alerts' Jason Cimpl what his favorite Chinese stocks were. He told me to pick 10 Chinese stocks, and then throw a dart at random and you'd likely get a stock that could double.
You could say Jason's pretty bullish on Chinese stocks. But I'll throw a specific name out there anyway: Puda Coal (Nasdaq:PUDA).
Despite a run in July from $7 to nearly $9 a share, Puda has a forward P/E of 4. And since it provides coking coal to China's steel industry, renewed growth for China would benefit Puda immensely. Puda's 52-week high is $11.90.