China is becoming a problem.
It’s not the military posturing, even though I’m sure we’re all aware of China’s confrontational military operations lately. It continues to threaten its South China Sea neighbors like Taiwan and the Philippines.
And that joint military exercise it conducted with Russia that encroached on Alaska’s Aleutian Islands really had me shaking my head…
It reminds me of those long family road trips when I was a kid. I don’t know if it was just boredom or what, but eventually, inevitably, my kid brother would start holding his pointed finger an inch from my arm and say “I’m not touching you, I’m not touching you…”
Of course, I’d appeal to mom, he’d ignore her “honey, leave your brother alone” pleas and I’d eventually whale on him because he just. wouldn’t. stop.
The U.S. has definitely whaled on China’s economy with the ban on high-end semiconductors and the equipment needed to make them.
And China has responded with some tit-for-tat restrictions of its own. And I suppose we could consider China’s various incursions on U.S. navy ships, surveillance planes and Alaskan islands as part of the tit-for-tat diplomacy that seem to define both countries’ behavior.
I don’t know how this all gets resolved, exactly, but I’m not overly concerned that the U.S. and China are past the point of no return regarding military conflict.
But that doesn’t really affect my concerns about the immediate economic threat that China poses…
The simple fact is: China’s economy, well, I don’t wanna say it’s melting down, but at the same time, it doesn’t look good. And as of right now, China’s weakening economy isn’t being considered a threat to U.S. and global economic growth. That might be a mistake.
The Global Economic Engine
For much of the last two decades, China’s economy has been the engine of growth for the entire world.
China’s voracious appetite for raw materials was a windfall for emerging economies. One of the best anecdotes I ever saw about China’s growth was this: between 2011 and 2013, China poured more concrete than the U.S. did in the entire 20th century.
The labor cost arbitrage that underpinned globalization was a profit margin windfall. And multinationals that set up shop in China to tap its massive consumer base was a growth windfall.
It doesn’t get talked about much, but it was massive stimulus spending from China in 2009 and 2010 (14% of its GDP) that helped the world dig out of the Great Financial Crisis.
It’s inevitable that there comes a time when all the highways and apartment buildings that need to get built actually are built. Even if China still has infrastructure needs, it’s much closer to the end of its building cycle than the beginning.
And it is China’s economy (not its militaristic aspirations) that are a big threat right now.
So right now, let me take you back in time to September, 2021…
Deja Vu All Over Again
On Friday, September 17 2020, the S&P 500 opened at 4,469. It closed that day at 4,432, just a couple points below its 50-day moving average (MA).
The following Monday, September 20, the S&P 500 opened at 4,402 and fell all the way down to 4,305 before recovering some during the session. From Friday’s high to Monday’s low, the S&P 500 peeled off 164 points, about 3.5%.
After a couple days, the S&P 500 recovered to around 4,450. Then it happened again. Over a span of 3 days, the S&P 500 +3% loss.
Now I know – a couple 3% drops for the S&P 500 isn’t the end of the world. As I write, the S&P sits at…4,469 (which is weird), a bit over 2% down from recent highs.
But it’s the reason behind those declines from September 2021…
It was a Chinese company called Evergrande, probably the biggest property developer in China at the time. The company was carrying $300 billion in debt and was in the midst of defaulting on an $83 billion payment.
Fast forward to now, and even with a government bailout, Evergrande is no longer the biggest property company in China. That honor goes to another company called Country Garden. And it too is in the process of defaulting on debt payment.
All told, Country Garden owes $199 billion in bond payments. And the next bond due has seen its dollar value fall to $0.11 cents – suggesting that default is imminent for this bond too.
But the thing is, China’s economy is in much worse shape than it was back in 2021. Its post-COVID economic recovery has not happened, consumer spending is falling and so is lending. Both imports and exports are falling and China’s economy slipped into deflation in July.
It’s true that the U.S. economy is less intertwined with China than it was back in 2021. Still, we’re not in a self-contained bubble. Plenty of U.S. companies have a lot of exposure to China.
There should be no doubt that some of the weakness we are seeing for stocks right now is related to China’s economic problems. And we haven’t seen any really big one- or two-day drops for the S&P 500…yet.
I’m sure there are investors out there wondering when would be a good time to buy in. I’m looking for the current Chinese economic situation to hit a crescendo that should include stimulus and bailouts by the Chinese government.
That’s it for me this week, take care, have a great weekend and I’ll talk to you on Monday.