The main headline on the cover of the January 16, 2016 issue of The Economist reads: Everything’s under control: China, the yuan and the market”. However, the accompanying cartoon image of a dragon plummeting downward with President Xi Ping holding the reins is far from reassuring. Why have the stock market, economic shifts, and currency in China come under so much scrutiny lately?
The tumultuous start to the year in the global markets has had many searching for its causation, and China has become a target. According to Liz Ann Sonders, Senior Vice President, Chief Investment Strategist, at Charles Schwab, in the Schwab 2016 Market Outlook webinar of February 2: the link between the action on the Shanghai Stock Exchange and the U.S. markets is the strongest it has been since 2008. (The U.S. markets have also been closely correlated to the rise and fall in the price of oil, but that is fodder for another blog.)
The tight link between the Chinese and U.S. markets has been extremely detrimental to the U.S., given that the Shanghai Stock Exchange has fallen more than 20% in 2016 as of February 1. Also, we should mention the unfortunate shutdown of the Shanghai exchange on two days in January, which correlated with steep declines in the U.S. markets on those days. Trading halted for the remainder of each day when a 7% decline triggered circuit breakers. The People’s Bank of China (PBOC) is adapting to their role running the exchange, learning when to intervene and when not to, and although government intervention is very unlikely to cease, the circuit breakers have since been removed. This should relieve some of the market pressure on the Shanghai Exchange and, hopefully, reaction in the United States as well.
Many are concerned that the days of high single-digit or even double-digit growth in China are long gone and that this could result in a global meltdown. According to a CNBC article dated January 18, 2016, “China’s economic growth rate slowed to a 25-year low of 6.9 percent in 2015, as the world’s second-largest economy continues to shift away from its manufacturing roots.” As referenced, China is experiencing some transitional pains as it attempts to move from a manufacturing-based economy to a more service-based one like our own.
Are these concerns about the impact of China on global markets realistic? While a slowdown in China has some impact on the U.S. economy because multinational companies like Apple and Nike sell products there, the U.S. economy thrives largely because Americans are buying goods and services here in the United States. Outside of the multinational companies, the effect of a slowdown triggered by China’s economy is considerably muted. As James Surowiecki (staff writer for the New Yorker and author of the regular New Yorker column, “The Financial Page”) reports, U.S. exports to China are less than 1% of our GDP. Thus, the economic link between the U.S. and China is virtually absent, a fact which may come as a pleasant surprise to panicking minds.
We do not dismiss concerns about China not discussed here, including the weakening of China’s currency (the renminbi) and high levels of debt. All things considered, however, we believe that the reaction here in the U.S. is overblown. Certainly unwarranted is a reaction so strong that January marks the strongest link between our two markets since 2008.