[dropcap]W[/dropcap]ith the focus off Greece, it turns out not everything is roses and lollipops. Broad indexes had modest declines, the first in six weeks. Economic news in the United States was mixed, but China and Europe disappointed. The U.S. employment picture continued to brighten and leading indicators rose, but existing home sales dropped slightly. Chinese factory activity slowed and BHP reported lower steel demand from China. Euro area services and manufacturing output dropped more than expected in February. Treasuries rose as some investors shifted to safer assets.
S&P 500: 1397.11 (-0.5%)
MSCI EAFE: -1.28%
US 10 Year Treasury Yield: 2.23% (-0.06%)
Gold: $1,662.65 (0.16%)
USD/EUR: $1.3269 (0.75%)
- Monday – Apple announced it will begin paying regular dividends and authorized $10 billion worth of share buybacks.
- Tuesday – China raised fuel prices by the most in two years.
- Tuesday – The US announced a preliminary decision to impose import duties on Chinese solar panels.
- Wednesday – February home sales dipped slightly from January and inventory increased modestly. The report was considered a mild disappointment but still points toward a firming US housing market.
- Thursday – European services and manufacturing output fell more than expected in February, raising concerns that the debt crisis could reignite.
- Thursday – Chinese factory output slowed so far in March, marking the fifth straight month of contraction.
- Friday – A system error on the Bats Global Markets platform caused a 9% “flash crash” on Apple stock, but it quickly resumed normal trading.
In the 1980s, it was viewed as obvious that Japan would become the world’s lone economic super-power. In the 1990s, the U.S. dominated. In the 2000s, China “proved” it would surpass the U.S. What should we learn? High growth is hard to maintain. The Chinese experience in the last 20 years has been nothing short of incredible. Now, the slowdown is coming.
This poses two big questions. First, will it be a hard landing or a soft one? Second, what does it mean? Consensus opinion is that it will be a soft landing. We are less confident. China’s economy is a strange blend of market and command. We know command economies are wasteful and eventually that must be paid for. Stories of desolate new construction in China abound. This implication is a tidal wave of bad loans about to hit. The Chinese government is unique in that it has nearly $3,000,000,000,000 (yes, those are trillions) in reserves. This means it will be able to bail out its banks once no other options exist. But by the time this happens Chinese banks will have ceased lending and growth will have slowed dramatically. The media continues to ask if the drop will be to 5% per year or 8% per year. We think the question should be – will it remain positive at all?
On the other hand, just as the end of the Japanese miracle was not the end of the world, neither will a Chinese slowdown be. Materials demand will be hit hard, and those producing it will feel the effects. However, this will have the halo effect of reducing prices for manufacturers in the rest of the world. China doesn’t let its huge population spend much money on US made products or services, so the consumer impact should be minimal. Western banks are not reliant on the credit quality of Chinese banks.
We don’t mean to trivialize the impact of China. It is huge. If a slowdown is worse than expected, stocks will get hit globally. But most of the U.S. economy won’t feel it much. In the end, China will be forced to implement more free market policies which will be good for everyone.