Are Markets Overreacting to China?

Dan Rohr: China has shouldered much of the blame for faltering global markets in 2016. Many suggest markets are overreacting. This view would imply either China isn't that important or conditions in China aren't that bad. Let's assess the validity of those two claims.

First: How important is China to the world economy? Possibly more important than any other country. It's been the number-one contributor to global GDP growth over the last decade. Meanwhile, dozens of countries have ridden China's coattails to better economic growth than they might otherwise achieved. Emerging markets like Brazil, Russia, and Indonesia, and developed markets like Canada, Australia, and even Germany--all of these countries face a tougher road ahead.

Second: How bad is the situation in China? Conditions are probably worse than the government has indicated. The government says the investment side of the economy grew 6.5% in 2015. But cement and steel figures suggest hardly any growth at all. On the consumption side of the economy, the government says growth accelerated to 8.9%. But that seems hard to square with falling consumer confidence and low-single-digit growth in everything from washing machines to instant noodles.

All told, we think the Chinese economy grew less than 5% in 2015. We are likely in the early innings of this slowdown. Debt grew twice as fast as nominal GDP in 2015. The interrelated problems of bad debt, excess capacity, and capital misallocation are likely to weigh heavily on China's growth prospects and the world economy in the years to come.