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China's Context

|Includes: BHP, Peabody Energy Corp. (BTU), MMM
If you are immersed in financial news daily as many of us are, it's very easy to become more and more caught up in the rapid changes. If you are watching the markets to find the right moment perhaps to trade a stock you own, particularly in what has been a summer of volatility, it's easy to get caught up in the moment by moment market changes.

Sometimes it's necessary to be immersed particularly if you are watching your stocks. After all, you can get up from the computer or away from the tv, walk out of the room, return a minute later, and incredibly, a stock you're watching has moved in price, perhaps even substantially. This summer's markets have reminded us how fast things can move.

While up to the minute real time information in today's investing world is necessary and beneficial at times, I wonder about the noise. Specifically, when one bit of bad news comes down, there is an immediate viral effect in the media. Take the US economic news. When the latest quarter's growth was revised downward to 0.7%, anemic by any standards, the financial media concluded, "recession's on the way," and soon this idea had spread.

There is, mind you, no recession yet, but the financial media, like the mainstream media, can get way ahead of itself. Then it extrapolates this data and all of a sudden the leap of logic goes from the slow US growth, adds in the eurozone confusion, and suddenly commentators are invoking a global recession. While there are legitimate concerns about the global economy, it's as if the market's desire to process forward-looking information has transformed into something else: jumping to conclusions.

What About China?

This phenomenon goes further. Because the US economy endured a brutal recession and has really never had a robust recovery, the assumption by some financial observers is that the world economies will plunge into recession—and they still can, especially given Europe's mess—where everything gets taken down in this scenario. Along with the cries that US growth is slow, others chime in that China's growth is slowing, too. So, observers will point out that the Shanghai Composite, at 2,437.68, is off 23% from its 52-week high of 3,167.72, and simply paint China's market with the same broad brush as the US and other stock markets. Not so fast, though.

China Shanghai Composite, one year chart

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China Is Different

The often knee jerk reaction was that the US financial markets took to this global slowing theme and applied it to the idea that China's economy was slowing, and this summer sold off many stocks which do significant business in China and emerging markets. The China slowing theme was a reason or an excuse for the markets to sell off the coal and iron ore producers, for example. Peabody Energy (NYSE: BTU), the US' largest coal producer with a significant presence in the metallurgical, or coking coal, trade and positioned strongly for Asian markets, saw its stock slammed from the $70s into the $40s. Never mind that the company still had outsized earnings.

This went on with all kinds of industrial stocks. Again, the steel trade, which uses the met coal, was deeply affected, and so were the iron ore miners. Mining giants BHP Billiton (NYSE: BHP), with the distinction of being one of the world's largest iron ore producers as well as a coal producer, saw its stock blasted down almost 30%. Clearly a case of overkill. Billiton was racking up record profits. Another case of market overreaction in selling a stock, maybe even getting it wrong.

BHP Billiton one year stock price chart

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Why China Remains Different

So the market took down these stocks because of their China exposure, and the market's always right, isn't it? Well, no. The financial markets do what they do, but they aren't always right. It's up to us as investors to constantly assess what the markets are doing in light of the economic realities and see if they are right. In this case, the superficial understanding of China's financial markets and economy in the west is what contributed heavily to the selloff in these material and industrial stocks. Even stalwart 3M (NYSE: MMM) was sold off, since it, too is an industrial stock and does business in China.

The Realities

The slowdown in China is nothing like the slowdown of the US economy. This seems self-evident, yet many US investors apply the same metrics to China's economy as the US. While the Fed in the US has been pumping money into the system and keeping interest rates at effectively zero, China has been systematically raising its rates to dampen too rapid growth. When is the last time we could talk about too rapid growth in the US?

Lian Ping, chief economist of the Bank of Communications in China, pointed out in a China Daily online piece that China's interest rate policy is working. China's August inflation backed off from its 37 month high, so Beijing can begin to pull back on the rate hikes and other policy measures. Lian described that the central bank's approach to monetary policy would be "prudently balanced." Lian added that inflation will moderate, which will put the economy in a position to grow in spite of the slowing global economy.

Investors need to remind themselves that the China economic picture is still different than that of the US and the rest of the world. What is the context for China? Growth.


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