Can We Stop Blaming China For Everything And Take Care Of Our Own Mess?

Includes: SPY
by: Marcus Valentiner


It needed several panic reactions by the Chinese government for financial markets to recognize that China’s economy continues to slow down, but this process already started two years ago.

The economic recovery in the U.S. remains weak, economic activity already started deteriorating in Q4 2014 and with that contributed to global growth concerns as much as China did.

Weak macro and corporate fundamentals in the U.S. also contributed to the correction in the stock market, which – in a vicious circle - will further hurt the already fragile economy.

The sharp decline in stock prices last week and on Monday found a quick explanation: China (economy and/or stock market and each seems to be the equivalent for 'global growth concerns'). In a distant second, uncertainties about the Fed's next steps also made the list, followed by a handful of hints in regard of oil prices trading at multi-year lows. No comment and no analysis mentions domestic issues; no mention of a weak U.S. economy whose annualized growth rate gets defined by how much inventories were added to or taken from the already record stock piles; no mention of the missing (operating) earnings growth and the revenue recession corporations find themselves in for a while; and no mention of minimal discretionary consumer spending and non-existent corporate capital expenditures.

First, it is quite surprising that financial markets just seem to have realized that developments in China might be problematic. It needs a 40 percent stock "market" correction and a surprise devaluation of the yuan (which poses more as a symbolic than a practical move) for investors to comprehend that economic growth in China is really slowing, despite a sharp deterioration in industrial production, electricity consumption, housing starts, automobile sales, retail sales, exports, etc. over the last 12-24 months.

Pointing the finger to China also implies that the U.S. and the world would otherwise be doing just fine but "what's bad for China is bad for the U.S." (not too long ago, didn't it sound like "when the U.S. sneezes, the world catches a cold"?). Having something or somebody to blame for always represents an easy way to stop analyzing and thinking and to continue pretending. This has been and continues to be a major mistake. The weather had been the scapegoat in Q1 2014 and 2015, then the energy sector was seen as the sole contributor for weak economic and earnings growth and now everything related to China turns into the perfect argument to explain a structurally weak economic recovery in the U.S. that has mostly been driven by record motor vehicle sales and some strength in the homebuilding sector. Unfortunately market action became very much short-term "event-driven" and general trends over the last months have been almost completely ignored. Many bears argue how far fundamental reality and asset prices diverted over the last two years (and the last nine months in particular) but looking at the data, there is little to argue against it:

  • The annual growth rate of wholesale sales peaked in July 2014 (+6.8%) and now declines at a 3.8% rate; even excluding petroleum, the growth rate peaked in Q3 and dropped to an almost flat 0.6% rate in June this year.
  • Growth in business sales (retail, wholesale, manufacturing) deteriorated from an annualized rate of 5.2% in July 2014 to -2.5% in June.
  • From June 2012 until December 2014, exports of goods and services always grew between zero and five percent. For the last six consecutive months, however, export growth has been negative, having reached an annual rate of -3.6% in June.
  • Despite an automobile-production-charged 0.6% monthly gain in June, industrial production slowed from 4.7% annual growth in November last year to 1.3% in June.
  • The growth rate for factory orders peaked in September last year, but showed negative year-over-year comparisons for the last eight months; in June total orders were 6.2% lower than in the same month last year, factory orders ex transportation were 7.5% lower and non-defense ex aircraft capital goods orders dropped 7.1% on an annual base. All manufacturers' shipments in June were 3.9% lower than in 2014 and at 1.35, the inventory to sales ratio is at the highest level since August 2009.
  • The Chicago Fed National Activity Index showed seven consecutive months of "below average" growth between December 2014 and June this year.
  • But consumer spending, which contributes almost 70% to the GDP, has finally picked up, didn't it? Personal consumption expenditures as part of the National Income and Product Accounts Gross Domestic Product grew 3.5%, 4.3%, 1.8% and 2.9% over the last four quarters. During that time frame an average of 40.5% had been spent on housing and utilities, healthcare and financial services and insurances, all non-discretionary items. The Bureau of Labor Statistic's Consumer Price Index for July showed "Medical Care" and "Shelter" as the only sub-components with prices growing north of three percent on an annual base, more than one percentage point higher than annual wage growth. By now, economists agree that the expected boost to discretionary spending due to lower gasoline prices did not materialize. After declining in December, January and February, retail sales have been mixed and extremely volatile. Retail and food service sales grew at an annual rate of 4.1% in August last year, the growth rate steadily dropped to 1.3% in July. With revolving consumer credit (aka credit card debt) jumping in March, April and June this year, it becomes clear, how retail sales were financed. To answer the aforementioned question, all data available shows that discretionary consumer spending did not see a sustainable pick up over the last few months.

These are just a few samples; the list goes on but what it demonstrates is that large parts of the economy continue to experience a broad deterioration of underlying growth. In many cases the annual growth rate already slipped into negative territory.

Since Chinese stocks started tumbling in the middle of June, optimists quickly pointed out that you cannot draw any connection between the local stock market and the economy. Yet, this link remained between the lines in the blame game and continues to be an argument that should explain the slowing world economy. In the U.S., the connection between the stock market and the economy is undeniable for a variety of reasons, including the famous "wealth effect" the Fed kept nurturing for the last six years. Most of the sentiment-driven surveys from consumer sentiment to the PMI series - still somewhat correlated to economic activity - carry the stock market performance as a sub-component. With U.S economic growth arguably not doing as great as frequently portrayed, the sharp correction in asset prices last week and Monday's crash will be felt in a further deterioration of macro and corporate fundamentals: Expect economic data and corporate results compiled after the last few days to meaningfully disappoint! Furthermore, this will strengthen the same reasons that contributed to the stock market rout of the last few days…

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.