That Spring Feeling Made You Forget About China

Includes: DIA, FCA, FXI, IWM, QQQ, SPY
by: Peter Newell


China's terrible economic news this week hasn't dented the markets' spirit. The rebound continues despite the warning signs.

The biggest takeaway from this week's China news is: unemployment is going to start to become a problem for the Chinese economy.

The government is laying off 5 or 6 million workers that have few opportunities, while millions of recent graduates are also unemployed.

Graduation season is almost upon us in China and we should expect more unemployed grads this year too.

Adding it all together, a real recession looms in China despite government intervention.

It's that time of year again, the sun is shining, the weather is warming up, and the markets are green across the board. The curious thing about it is that the positivity kept running high even as more data came out indicating that China's economy is getting weaker by the day. Has the market really priced in the worst-case China scenario? No, I don't think so. Has China lost its value to the American economy, American businesses, and the markets? No. Are investors collecting their thoughts and taking a break from selling the warning signs? Seems like it.

After all, it's common for the markets to rebound or pull back after extended directional moves, before continuing the trend. I think this is the biggest reason that China's moves this week haven't dented the markets' positivity. After all, we knew the economy was sick. January's trade data implied that manufacturing would be down. The ongoing challenge of propping up the Yuan makes it no surprise that it's fallen in the face of super-bears and market forces.

It's not even surprising that the Chinese government broke its promises from the G-20 meeting just a few days after making them. Namely, the head of the PBOC pledged to keep the Yuan stable and not to rock the boat. So I assume that investors already expected the currency to fall and some looser policy.

The Unemployment Problem

So that's all well and good. The markets have priced in the bad data for February, given that it was a short month for China, considering the Spring Festival. However, the markets do seem fairly optimistic for what is essentially a fair warning sign that things are going to be worse moving on. In addition to the headlines I've already mentioned, China announced that it plans to lay off 5-6 million workers in various secondary sector industries.

This is being done to reduce overcapacity in steel, coal, and manufacturing. But it also begs the question: what is China going to do with another 5-6 million low-skilled workers? They're surely not going to be transitioned into service industries and the government can't take care of them the rest of their life. They can be retrained, but who will pay for that? Most certainly the workers won't be able to afford the cost of going back to school and not working.

Then, of course, we have to consider that millions of college graduates from last year still don't have jobs, and that the layoffs in the country are just the beginning. Of course, college graduates this year will be facing a tougher employment market, which is going to add more stress to the economy. The unemployment issue is going to make it harder for China to restructure its zombies, which creates another slew of questions.

Pricing it in

Considering the amount of investment that American and European companies have poured into China over the years to develop the retail market, growing unemployment and more uncertainty over revenues from China aren't going to help companies like Apple (NASDAQ:AAPL), Nike (NYSE:NKE), or Ford (NYSE:F). It can be argued that global markets had already priced in the February data from China, but it certainly does look like we are ignoring some of the growing storm clouds in the East.

As global trade trends downward, China is a country that bears the brunt of the pain. With falling revenues from overseas and significant overcapacity in nearly every sector of the economy, the country is going to have to eliminate more jobs and draw down its currency reserves even further. The other fear is that a much weaker Yuan is going to exacerbate deflationary pressure around the world.

In other words, for all intents and purposes, China should enter a real recession in the near future as the government runs out of money with which to prop up zombie corporations and the currency, and there are fewer workers in the country producing and buying things. While the S&P has fallen roughly 17% this year, China hasn't been the only driving force behind the selloff.

Let the bulls play

The conclusion here is an obvious one: China's economy is going to continue to get worse. How much worse is hard to say, but Moody's isn't very optimistic about it either as it downgraded China's credit today. But between now and new defaults by foreign-listed Chinese companies, enjoy the bull run and keep a weathered eye on the horizon.

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.