Wow, the market doesn't seem to being going up anymore. While the S&P 500 and its tracking exchange traded fund, SPY (SPY), are up nearly 20% from the summer lows of last year, and stocks such as Apple (AAPL) are up nearly 30% this year, the market has sold-off for nearly a full month now.
Indeed, while the S&P 500 and most of the broader indexes have declined fairly steadily, many individuals stocks, such as Citigroup (C) and Apple, in key leadership sectors, such as technology and the financials, have sold-off nearly 20% during the last several weeks.
However, despite the poor recent market performance, the U.S. economy continues to grow at 2-2.5%, recent earnings reports from Citigroup and JPMorgan (JPM) show a significant improvement in debit and credit card transactions, and the economic data in China has improved mildly.
Yields on major oil and consumer stocks are now over 5%, volatility levels remain low, and companies such as General Electric (GE), Caterpillar (CAT), and IBM (IBM), are trading at reasonable valuations at around 8-11x average estimates of next year's likely earnings.
Still, cheap valuations aren't enough to move the market higher, catalysts must exist.
The economic data in China is interesting to me, since the market has now known for some time that the economic activity in the eurozone remains weak, and the unemployment rate in the U.S. is improving very slowly. Also, since the U.S. and Europe are in major election years, new and significant stimulus efforts from European governments or congress are unlikely in the near-term.
Recent housing and trade data in China have generally been better than previous quarters. China's recent trade report was mildly disappointing, but the largest developers in China have showed increases in apartment sales for the first time in almost a year.
Today, when you adjust Chinese economic growth for currency appreciation, real growth is tepid in the world's second largest economy, despite the country's official 7-7.5% growth rate.
China now has a new government for the first time in nearly a decade, the Chinese central bank has begun to lower rates, and most commodity and other inflationary pressures are continuing to drop. While I have been skeptical of China's ability to engineer a "soft landing" in my previous articles, the economic data in the U.S. and China has improved over the last year.
While just a month ago, copper and oil prices were at the high end of these commodities' 3 year ranges, oil has fallen nearly 13% this month alone, and copper prices have fallen around 15% from the red metal's highs earlier this year.
Recent earnings reports and guidance from companies highly leveraged to the Chinese construction industry such as Walter Energy (WLT) and Cliffs Natural Resources (CLF) have been disappointing as well and Chinese index funds such as the FXI (FXI) have underperformed the S&P 500 and its tracking exchange traded fund, SPY, by a fairly wide margin.
In China, the idea of saving face is tremendously important, and the new Chinese government will not want its first years in power to be economically disappointing.
Today, despite the trillion dollar surplus China has on paper, Chinese citizens do not have the same kind of social safety nets the West has with programs such unemployment benefits, social security and medicare. As inflationary pressures drop but growth remains tepid, China will likely look to various different ways to stimulate growth.
While China's previous stimulus initiatives focused on real estate and infrastructure, it is likely that given the overbuilt condition of the real estate market in many Chinese cities today, China will probably focus future stimulus spending differently. With Europe being China's biggest customer, China may look to partner with the U.S. through the IMF to provide assistance to Europe, or invest directly in assets and company's in the eurozone.
To conclude, while commodities and stocks have been heavily correlated during the nearly six month market rally, lower inflation expectations will provide benefits to consumers, and governments will have more flexibility to engage in stimulus as well.
China's growth number of 7% is impressive on paper, but the country's real growth, excluding currency appreciation, remains tepid, and Chinese stocks have underperformed most of the broader indexes during the last year by a fairly wide margin.
While the U.S. and European governments will likely remain on the sidelines during an election year, China's new leadership faces few political hurdles if the central government and central bank want to take stronger action to help stimulate growth in the world's second largest economy.