Why the World Is Worried Over China

Jason Stipp: I'm Jason Stipp for Morningstar. Welcome to The Friday Five, Morningstar's take on five stories in the market this week. Joining me with The Friday Five is Morningstar markets editor Jeremy Glaser.

Jeremy, thanks for being here.

Jeremy Glaser: You're welcome, Jason.

Stipp: A lot of focus on China this week, with good reason. It was in the headlines all this week. Let's start with some of the reasons China saw the sell-off that it did.

Glaser: It was a bit of a crazy week for the Chinese markets and the global markets as well, including a trading session in China that lasted for less than 30 minutes because of the circuit breakers that were put in place.

When I spoke to Dan Rohr, our China analyst here at Morningstar, he attributed this to three big factors. The first is fundamental. We do see more evidence that China is slowing and is not growing as fast as many people thought. There was some data on Monday that underscored that, but we've seen this data trend for a while, and I think the market became very focused on this all of a sudden. A lot of these concerns are the same ones that we've had for months now. If you remember, the Chinese market had similar turmoil in the middle of last year, and we're seeing that continue to play out--worries about what's happening there.

There was some technical reasons. These new circuit breakers that were put into place this year seem to have acted as magnets to pull stocks down to those levels as people were concerned about what would happen when the markets actually closed. It seems like getting rid of that on Friday did at least allow for some stabilization in the China market, if not a big rebound. It was good to see that adjustment.

And finally, there are some behavioral factors. The Chinese market probably is more sentiment driven and less driven by the pure economic fundamentals or the earnings of companies. You see a lot of people trying to bet on where the market is going to go versus where the fundamentals are going to go. Is it going higher or lower, and what is government intervention going to do? I think we saw a lot of that happening, which can lead to some of these big swings. It is a market that tends to be much, much more volatile than we see anywhere in the U.S.

Those factors combined to create a pretty hectic week.

Stipp: Story No. 1 this week was all the volatility we saw in China. Story No. 2, though, was volatility in the rest of the world. It wasn't just China that sold off. Other parts of the globe also sold off. Maybe not as severely, but we did see stock sales.

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Glaser: What was happening in the Chinese markets seemed to have an impact. Europe saw some very big declines. The U.S. saw some big declines. Certainly this was a global phenomenon, not one just focused on China.

There's a lot going on here. Part of it is directly on China, including concerns about the Chinese currency. What impact does that have on other emerging-markets currencies? Do we have a currency war, and how does that play out? I think that weighed on investors.

What's happening with trade? Are we going to see a big reduction in trade from China if it does slow a lot? Who are the winners and losers there? That was very much in focus.

You also have to remember, we did just have a Fed rate increase. Although most of that we think was priced in and did not have a big impact immediately, I think investors are starting to think about, what does it mean if there are going to be quite a few increases in 2016, and the Fed rate does end up significantly higher than rates across the world? What are the currency impacts, the trade impacts, the global impact of that?

There were also geopolitical worries in the Middle East and North Korea, and an earnings season coming up that maybe won't be the strongest that we've seen. You add all this together and certainly the recipe was there for this volatility.

And don't forget that valuations were still at pretty high levels as we entered this week, and aren't exactly cheap now. We've had stocks, at least in the U.S.,  priced for things to go pretty well, so there was room potentially for those declines, as investors take a slightly more bearish view of the world.

Stipp: You're not painting a pretty picture here with issues in China and also some concerns at home and high valuations still. What should investors do at this point? What's the takeaway for them?

Glaser: Well, I think panicking is not the right answer. Saying, "This is a terrible start to the year; I'm just going to sit out of stocks for 2016"--I think that's probably not the right answer for the long term.

The first thing is to step back and look at your asset allocation. Ask yourself, why do I have money allocated to equities in the first place? What am I trying to get? It's probably long-term growth, and for most investors that is still the right path as long as it's within that allocation decision that makes sense for the time horizon you have.If you have 30 to 40 years until retirement, or you have a part of your retirement portfolio you are trying to grow, it makes sense to have that in risk assets.

It's very difficult to time the market and say, "This is going down right now; I'm going to get out, then I'm going to come back in. I'm going to go out and in." We just haven't seen a lot of evidence that investors are particularly good at figuring out when is the right time to make those moves.

And there are always going to be reasons not to invest. There is always something scary going on in the world. There's always going to be uncertainty. These are things that just aren't going to go away. There's never going to be a perfect time where everything seems sunny. And when it does, there probably aren't going to be any values to be found in that kind of circumstance.

So it's important for investors to keep a long-term focus, to make sure that they're within the allocation bands that they want to be in. Make sure you're not taking outsized risks right now. As we've mentioned, given where the valuations are, this is not the time to swing for the fences, but it isn't time to totally retreat, either.

Stipp: A couple of other news items this week. The job report on Friday was better than expectations. That was a bright spot out of the week. What's your takeaway there?

Glaser: When you look at all the weakness that we're seeing in China and other emerging markets, and concerns about Europe not growing as fast as they would like, the U.S. economy still seems to be chugging along. It seems that job growth did accelerate toward the end of the year. We added 292,000 jobs in December, well above expectations. Fifty thousand-plus jobs were added in revisions to the previous months.

That's a pretty substantial number of jobs added. We saw a similar pattern in the previous year. It seems like employers are in a rush to get things done by the end of the year. These numbers should be seasonally adjusted, but Bob Johnson, our director of economic analysis, thinks there still is some seasonality in there, and that the adjustments haven't caught up with what's happening in the marketplace right now.

So, you see this strong jobs report, you see it being pretty balanced across a lot of sectors, manufacturing not totally falling apart. Retail, particularly brick-and-mortar retail, is still having some trouble, which may be as expected given the holiday season. But for the most part, it was a solid report and a sign that the U.S. economy is still chugging along. It doesn't mean we're about to take off toward a huge amount of growth. But I think it is a sign that the U.S., at least for now, is able to withstand some of these issues that are happening abroad.

Stipp: Lastly, an interesting story in the auto sector, with GM saying that it's going to invest in Lyft, in something that also involves self-driving cars. What's the rationale?

Glaser: This is something completely different. After a week that was a little bit stressful for a lot of investors, it's interesting to talk about something a little bit more long term, which is GM making a $500 million investment in ride-sharing company Lyft.

This is less about ride-sharing as it is about autonomous self-driving cars. They're going to work together to create an on-demand self-driving car network, so that you could open up your Lyft app, and a GM self-driving car will pick you up and take you to where you need to go. They think, and our auto analyst Dave Whiston agrees, this will be how self-driving cars are rolled out. It's unlikely at first that private ownership of them will be feasible for various reasons. These fleets will likely be the way that they get introduced into the marketplace.

This is GM looking ahead, and seeing, what happens if private car ownership just isn't as prevalent as it is today. How do we adapt to that world? This is just part of that strategy; they're also looking at developing some of this stuff in-house. Dave Whiston expects to see a lot more deals like this across different auto companies, across different platforms, as everyone tries to figure out how to adjust to this new world.

It's not something that's going to happen overnight. It will be 10 to 20 years before we see this trend really play out. But it's certainly an interesting one for people who watch the auto sector to keep an eye on.

Stipp: Thanks for the insights and perspective on what was a rocky week in the market, Jeremy.

Glaser: You're welcome Jason.

Stipp: I'm Jason Stipp for Morningstar. Thanks for watching.