Headlines about the slowdown in the Chinese economy have been quite rampant lately, with some economists going as far as calling for a Chinese economic hard landing. The Chinese government has recently forecast a slowdown in China's GDP to 7.5%, while BHP Billiton Ltd. said that China's steel production is slowing. As a result, U.S. equity markets dropped in the morning of 3/20/2012, as commodity prices retreated, including a pullback in oil and gold prices.
In an article we published on 2/27/2012, "oil price spike may not justify buying big oil", we listed several factors, at a time when oil prices were making new highs, that underlined the risk for oil prices to drop in the near future. As a result, it was suggested that it may be best to book profits on big oil companies, Exxon Mobil Corporation (XOM), Royal Dutch Shell (RDS.A), Chevron Corporation (CVX), British Petroleum (BP), Total (TOT) and Conoco Phillips (COP). Since then, with a pullback in crude oil prices from recent high levels, most such stocks are down as of 3/19/2012, with the exception of Chevron and Conoco Phillips.
|Stock Price as of 12/31/2010*||Stock Price as of 2/24/2012*||Stock Price as of 3/19/2012*|
|Exxon Mobil Corporation||$71.04||$87.34||$86.99|
|Royal Dutch Shell||$62.95||$73.54||$71.99|
There are additional indications that crude oil prices may remain on the defensive for the time being. In a recent article by Bloomberg, it was reported that Saudi Arabia can increase crude oil production capacity by as much as 25% if needed. In addition, it was reported by CNBC that Blackstone's Wien said that "oil prices will fall as Iran tensions ease."
A slowdown in the Chinese economy, which may lead to an easing in commodity prices, can possibly ease any future inflationary pressures. Such scenario, where commodity prices remain in check while U.S. growth expands, is actually a positive development in the intermediate term for the U.S. economy as well as for the stock market.
In such case, it is more likely that interest rates would remain low, while inflation remains in check, although commodity prices are not the only determining factor for inflation. In addition, lower oil prices will increase the disposable income for U.S. consumers, hence increasing consumption for other goods and services, as discussed in our article published on 3/12/2012, "2 stocks that can benefit from China's slowdown." Meanwhile, it is estimated that a sustained increase in oil prices by $10 would result in a 0.5% drop in U.S. GDP growth rate over two years. Logically, ceteris paribus, a drop of $10 in oil prices would provide a boost to U.S. GDP growth rate.
If a hard landing does materialize for China's economy as predicted by some analysts such as J.P. Morgan Chase strategist Adrian Mowat, then it is possible that the financial ripple effects will be felt globally, especially if China retreats from its large purchases of U.S. treasury securities. China is the second largest holder of U.S. treasury securities, currently holding about $1.132 trillion in U.S.debt. The largest holder of U.S. debt is actually the Federal Reserve and other intergovernmental holdings, with a total of about $6.328 trillion.
We believe that a hard landing scenario for China is unlikely, as China's slowdown has been somewhat deliberately engineered by the Chinese government in order to slow down China's speculative real estate boom. Hence, it is more likely that China will experience a healthy soft landing, a scenario that may not prove to be healthy for Big Oil companies, but which may prove to be healthy for the U.S. economy.