Mon, 4 Jan 2016
The U.S. economy is mostly insulated from a slowing China, but that doesn't mean a smooth ride ahead, says Morningstar's Bob Johnson.
Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. Global markets tumbled today on renewed China fears. I'm here is Bob Johnson--he's the director of economic analysis at Morningstar. We're going to look at what people are worried about in China and how it's going to impact the U.S. Bob, thanks for joining me.
Bob Johnson: Great to be here today.
Glaser: So, what exactly woke the markets up from their holiday slumber? Why are things down so much today?
Johnson: Well, you've always got to be careful about being too simplistic and overanalyzing one piece of data, but the main piece of data out today was the Caixin--a purchasing manager index on manufacturing in China. That's the index that covers smaller or midsized companies. And that number came out down from 48.6 to 48.2 month to month--and that's the December reading. And that was a bit of a disappointment. People had seen industrial production tick up a little bit as well as retail sales a little bit. The survey of major manufacturers--the larger companies--was actually up a little bit in the report last month, so everybody was thinking, "Well, maybe this'll be a little bit better of a number this time around." That surprise element is maybe why it's had such a dramatic effect, but the number did take the market by surprise, and it reacted accordingly. And I will say that this has been kind of a move-heaven-and-earth type of number. This report, outside of the Fed report, has always been the most market-moving report out there. It's a little scary every time this report comes out because the reaction is always strong, in either direction.
Glaser: So, that maybe explains some of the movement in Chinese shares, but why are we also seeing this big impact on U.S. markets? Is it just in terms of earnings in China? Is it just worries about contagion? What's happening here?
Johnson: Well, there's certainly a little worry about contagion. Certainly, China has a large impact on other emerging markets, and it certainly has an impact on multinational corporations that operate in China. And those multinationals, even though they're based in the U.S., may actually produce and sell those products out of some other country--not out of the U.S. As I've said many times before, China represents less than 1% of U.S. GDP, so the direct impact on the U.S., for most companies, should be a little bit more muted than the reaction that we've seen in China.
But there are some companies that are quite dependent on China for growth, and there will be more impact on an individual-company level. And anything in the commodity complex. Certainly, manufacturing, in particular, being weak. The coppers and the lumbers of the world are impacted. And certainly U.S. participates in and exports goods in those categories. The companies that process those commodities--say a John Deere (DE) or a Caterpillar (CAT)--haven't done all that well recently either, and this certainly won't help matters there.
Glaser: When you see a number like this out of China, does it change the way that you think about the U.S. economy or your forecast for the U.S. economy? Does it have that kind of impact?
Johnson: Because it is a relatively small number relative to our exports, it doesn't necessarily have a huge impact on the U.S. economy. There are a number of areas where it could have a potential impact, however.
Glaser: What would be your biggest fear regarding how that contagion could hit the U.S.? You mentioned commodities. Are currencies another area that you're watching here?
Johnson: With [China's] currency eroding, it makes their goods cheaper here in the U.S., so it'll make them more competitive here, and it will also tend to spread their deflation from there to here. And we've already seen some deflationary scares on the goods side--certainly not on the services--but this will enhance those fears on the goods side.
Now, that also can potentially be good news for the consumer, in that the consumer that buys goods is now going to have lower prices. Probably another factor is that the Fed may have to reconsider what they're going to do with interest-rate policy. Recall that the last time they delayed the rate hike--in the late summer/early fall--it was because of all the issues in China. I don't think they mentioned them by name, but they may have mentioned overseas markets and turbulence and so forth. So, that certainly may be on their mind again this time because the [market] move was rather large. So, we'll have to see. In addition, it will tend to keep inflation down, and that's something they're trying to get up a little bit. So, this may even weigh on the Fed's decision.
Glaser: You said this number was kind of surprising in that it was down but the raw number wasn't so terrible. What's your outlook, then, for the Chinese economy? Do you think that they can continue to muddle along at slower growth or are we looking at maybe a deceleration even more so from where they are now?
Johnson: I've continued to say that China's not as strong as people think it is. And I've also been pretty firm in the fact that I don't think their economy is falling apart either. They're intentionally going through what's always a painful process. We've seen it play out in Korea; we've seen it play out in other emerging markets. When you shift from a country that's based almost entirely on exports to one that's more focused on internal demand--and also is less focused on investment and more on consumption--it's a painful transition. It's hard to grow consumption versus growing investment. With investment, you just kind of throw more money at it, and multiyear projects get spent in single years. That tends to help economic activity. Then, when you slow back to a more consumption-based economy, when it grows more in the level of income growth, you'd have a slowing. And that's what's happening there right now. I view that as a normal process, but it's not always painless.
Glaser: So, for long-term investors looking at this who see the Dow down more than 400 points this morning, should they be concerned? Should they think about finding opportunities? Should they be staying put? What would be your advice to them?
Johnson: Well, I wouldn't let this event in China sway your overall view. A good, balanced portfolio with good exposure to equities, I think, is always a good thing. And I don't think even China is out of the picture for the long term. They may have some difficulties in the next six to 12 months in terms of their stock market; but again, it's a pretty rapidly growing overall economy compared with developed worlds, which are growing around 2% at best. It's certainly growing faster than that--even with all of their issues. So, it's not an area that you want to ignore necessarily, either.
And I don't think the contagion effect will necessarily be very strong. Unlike the U.S. housing market, where we sliced and diced mortgages and sold them to every corner of the world, the Chinese debt issue, while getting larger, is certainly more contained in China--and even within levels of the Chinese government versus being owed to outsiders.
Glaser: So, it's probably not worth sweating some of these China fears?
Johnson: No. I think things in the U.S. can be volatile; it certainly doesn't help to start the year off on such a large down note--to have this much to overcome from the get-go. Old wives' tales on Wall Street suggest that if you start off badly, the year usually doesn't turn out so great. So, that's not necessarily wonderful news. And certainly U.S. growth isn't maybe what everybody thought it was going to be.
All of those things will continue to weigh, and evaluations aren't the best we've ever seen. But that said, I think the U.S. is relatively well positioned compared with a lot of other countries of the world. [The U.S. has] better population growth and exposure to great industries. I think all of those things will help the U.S. market to continue to do--on a relative basis--pretty well.
Glaser: Bob, thanks for your thoughts today.
Johnson: Thank you.
Glaser: For Morningstar, I'm Jeremy Glaser, thanks for watching.