China Lands Softly

October 26, 2012

There’s been consensus for at least a year now that China’s rate of growth will inevitably contract from 2011’s pace of 9.3%. What’s less obvious is how severe the slowdown will be; predicting is notoriously difficult because of the lack of GDP data from the Chinese government. Still, the outlines of what’s being called a “soft landing” and its consequences are becoming clear: China’s growth is expected to decelerate to 7.7% this year.

With much of Europe in recession and recovery in the United States only beginning to show signs of strength, a strong Chinese economy has been critically important for the global economy. In the United States, reduced demand from China is estimated to have lowered American growth by 10 to 20 basis points in the second quarter (a small amount but a fairly large percentage of the 1.3% annualized rate for the quarter), and to be responsible for the loss of 38,000 manufacturing jobs since July.

China is the third-largest buyer of American goods after Canada and Mexico, accounting for 7% of worldwide American exports. Chinese demand is not only a major driver of American manufacturing but also a major factor in the rise of prices for American commodities like coal, paper, and many metals. The cooling of the Chinese economy can be expected to have further short-term effects on U.S. employment growth and profits, and long-term effects on the success of the American recovery.

China, of course, isn’t sitting idly by while growth slows. It has long-term goals of shifting its economy away from heavy reliance on exports and toward domestic-driven growth, and of liberalizing its capital markets to create efficiencies that spur innovation in the economy at large. China’s ability to manage change is hampered, however, by rising labor costs and an aging population, and by the once-a-decade turnover of its leadership that happens at the beginning of November.

Some have an image of China as a centrally managed monolith. It isn’t, though, or it wouldn’t have accomplished the greatest modernization in the history of the planet. It will be interesting to watch how the country and its political and business leadership deal with the first hiccup in that extraordinary growth. Stay tuned.



The Next Four Weeks

October 15, 2012

Over the next four weeks, we’ll learn who will be President for the next four years, how companies performed in the third quarter, and Europe’s plan for further integration of its financial system. That’s a lot of news, and that news is likely to create movements in the market. As we parse through all the information, we’ll be watching for the news that will actually move the market from what we believe is just noise. We consider market-moving news to be:  news that gives us clues to companies’ future earnings, and news that gives us clues to the future of interest rates.

The presidential election is important because it may have an impact both on how much companies earn and on interest rates. Up for debate is how to deal with the United States’ growing deficit. As we see it, there are three ways to deal with the deficit:  First, raise taxes. Second, raise growth, which increases tax receipts. And third, raise inflation so that the dollars we have to repay are worth less than the dollars we borrowed. Growth is everyone’s first option, but few economies have ever outgrown their debt issue. Tax changes and inflation seem to be more likely occurrences. Higher corporate taxes could weigh on corporate earnings and thereby equity prices. More inflationary policies would signal higher future interest rates and as a result likely lower stock prices. How each candidate would deal with the deficit as President is a major consideration.

Over the next four weeks, companies will report third-quarter earnings. Ever since the depth of the recession, U.S. corporate earnings have continued to surprise Wall Street analysts to the upside. During the last three years, most of the gains have been from greater efficiency (e.g., cost-cutting or increasing worker productivity), as opposed to strong revenue growth. At some point, all the costs will be cut and earnings growth will require some degree of revenue growth. As earnings start to be reported, we’ll be looking to see if earnings are benefiting from the recent quarter’s uptick in spending and employment. We would like to see corporate revenue growth as a sign that future earnings growth rate projections are sustainable.

Finally, there is Europe. Spain may ask for a formal bailout in the next four weeks. That bailout will be the final test of how well Europe has managed to build its backstop to put a halt to its slow-moving debt crisis. Almost more importantly, we expect to see some movement over the next four weeks in Europe’s plan to produce a continent-wide bank regulator. Such a move would do a lot to calm market fears about a eurozone breakup, and thereby reduce interest rates in Europe and aiding stocks overseas.

There is going to be a lot of action to watch over the next four weeks. We will be monitoring the situation closely, and then looking to take advantage of opportunities where applicable and updating you with our thoughts.


Good News on Housing

October 5, 2012

The housing market is coming back.


S&P’s Case-Shiller home price index of 20 major metropolitan real estate markets for July is out today, and the good news is both broad and deep. Prices were up 5.9% for the first seven months of the year, their largest year-to-date gain in seven years, and significantly better than increases in 2011 (0.4%) and 2010 (2.1%). Prices rose in 16 of 20 markets compared with a year ago, and while they’re still 30% off their 2006 peak, it’s important to remember how inflated those 2006 prices were.


Even better is the depth of the improvement, as prices increased even in the cheapest homes. The gap between price gains in the high end of the market and the low end has narrowed, and the bulk of the gains come from the bottom and middle tiers. Even though four of the 20 Case-Shiller markets aren’t showing the gains, and Atlanta in particular is lagging, the trend is undeniably positive. Reinforcing it are data that show single-family housing starts well ahead of last year’s pace, existing home sales are up, the inventory of homes for sale is down, and foreclosure activity is slowing.


Rising home prices increase the net worth of home owners. And, as a result, the improved balance sheet has a psychological impact, causing people to feel better about their situation, and this reduces frugality. If their home price increase allows them to refinance at lower rates, the impact is multiplied.


There’s more. The Conference Board recently reported that its consumer confidence index rose in September to its highest level since February. Remember that consumer purchasing drives 70% of the American economy and it dovetails nicely with renewed optimism; the number was well above August’s level and also well above economists’ expectations.


Are we finally seeing the beginnings of a self-sustaining recovery, where the trends reinforce one another and a pattern of economic growth becomes clear? It’s still too early to tell, but it’s not too early to be cautiously optimistic. Growth won’t be a straight line up and there are other important economic factors to deal with, like job growth, but it is encouraging to finally see progress in home prices.