The big story over this past weekend was the economic news coming from China – data which reveals a China radically different from the one the existed a decade ago.
What the data shows is that China is pulling out of the economic “slowdown” that it suffered along with the rest of the world over the past two years. (We put “slowdown” in quotation marks, because what passes for slow growth in China would look rapid in the U.S.) Industrial production beat analysts’ expectations. Imports have surged higher.
If you've been following our commentary, China's performance probably comes as no surprise. In fact, one investment which we have often recommended is The China Fund (CHN). At the moment, it is trading at all-time highs – yes, higher than its peak in 2008. We like CHN because it holds a collection of excellent Chinese consumer stocks. The pick-up in Chinese imports confirms our expectation that consumer consumption in China is on the rise – exactly what the Chinese government has been encouraging.
The only negative in the recent economic news from China is that the Chinese inflation rate stands at roughly 3.5%. But even the Chinese government (which ought to know) expects that inflation will fall in the fourth quarter – partly due to higher comparisons versus a year ago, and partly due to ample food supplies. (Food prices in China are frequently affected by droughts in the Northwest, however, these have been fewer than average in recent years.)
CHINA VS. THE U.S.
China is now the 2nd largest economy in the world, as measured by Purchasing Power Parity, (or in terms of total goods produced), which compensates for currency valuations. It may seem odd therefore that number 2 can have such a huge affect on U.S. markets.
However, we must remember that China and India together (or Chindia) make up a block that is larger than the U.S. The developing world as a whole, in which China is the primary engine, has grown to the point that it likely equals the size of the developed world. Consequently – and in contrast to the way things used to work – when China sneezes, the world catches a cold. And when China gets a second wind, the world's sails are also filled.
We therefore think that good news from China will eventually benefit the U.S. markets as well – but it may take some time.
For example, few markets correlate better with the iShares FTSE/Xinhua China 25 Index (an ETF that tracks an index of the top 25 Chinese blue chip stocks) than the prices of base commodities such as copper. Copper, which jumped about 2.5 percent on the China news, is closing in on all-time highs.
As for industrial commodities, the raw materials not listed on futures exchanges, they are already within a whisker of their all-time highs. Who would have expected that, with U.S. suffering from 9.6% unemployment? Yet the developed world, which is led by the Chinese economy, seems strong enough on its own to push industrial commodity prices higher at a faster rate than U.S. economic growth.
In fact, any rally in the U.S. will likely be short-lived. If corporate earnings are not held down by consumers too worried about tomorrow to ramp up spending, they will be eroded by higher raw material costs. Quite possible both factors will impact stocks.
Just about the only real positive sign for the U.S. economy has been recent weakness in the U.S. dollar. Earlier this year, the euro was losing buying power in dollar terms, thanks to the debt crisis in Greece and other member states. But this summer the trend reversed and the dollar started falling. If we look at the history of the past 10 years, we can see that the dollar really only rises when people are scared, since the dollar is still perceived as a safe haven. Today, with China surging and commodity prices strong, people are less scared than they were 2-3 weeks ago, so the dollar is off once more.
If only the dollar could maintain its downtrend, it would help the U.S. economy by making our exports more competitive thus helping our trade balance, and perhaps fostering the creation of new industries. But the problems that plague Greece, Ireland, and the other PIIGS nations are unlikely to go away soon. Their debts are off the charts; we literally don't know the full amount. So the euro will most likely resume its downtrend versus the dollar.
We were somewhat amused last week when the Norwegian sovereign investment fund made a purchase of Greek bonds. Who do they think they're kidding? This was clearly a move to counter the negative sentiment that has developed regarding Greece in recent months. We don't think it will work. The debt crises in Greece, Ireland, and the rest are too big to be solved by such a purchase. While it might buy Europe some time, it cannot postpone the disaster forever. When this becomes clear, it will short-circuit any rally in the dollar and prompt more quantitative easing.
We don't know whether the next crisis will come this quarter or next. All we know is that China and commodities are where the money will be made. Emerging markets are the driving force in today's world, and they are driving commodities higher. Gold may play second fiddle to these areas for a while, but not for long.
Under these conditions, you should consider investments such as the PowerShares DB Base Metals exchange-traded fund (DBB), which is a wonderful collection of copper, aluminum, and zinc. Enjoy the remaining upside the market offers over the short-term, but know that it is not the start of a new bull market. None of America's problems have been solved.
For those still concerned about China's alleged property bubble, we remind you that China has much more control over its economy than the U.S. government. It has yet to raise interest rates, and has brought much of its property market under control. If anything, China's major problem is that it can't build houses fast enough to satisfy demand from the 400 million Chinese citizens who will be moving to cities over the next decades. What a great problem for home builders to have!
We think China will solve its housing shortage, and that the wave of construction will continue to create boom times for commodity investors.