STA Weekly Report – China’s Economy and the Implications for Global Equities
Written by Luke Patterson | Wednesday, January 23rd, 2019
INSIDE THIS EDITION: China’s Economy and the Implications for Global Equities A Lot of Moving Averages Are Being Tested Transports and Energy Stocks Slip Below 50-Day Lines – Small Caps May Be Next Early Bounce in S&P 500 is Fading Weekly Snapshot of Global Asset Class Performance 401k Plan Manager*Updated on 12/31/2018
As far as global economies go, China is without a doubt one of the most important geographies for investors to keep up with. It is the world’s largest manufacturing economy, maintains a leadership position in terms of exports, and represents a fast-growing consumer base.
With these characteristics, it is no wonder why China is able to provide consumers in the United States with inexpensive goods and provides support to the world economy through strong demand for goods and services produced outside of China. However, there is a potential downside – the Chinese economy is so important to global economic activity that any deterioration in the Chinese economy has the potential to trigger economic deterioration elsewhere. This is the nature of a complex global economic system.
So what is going on in the Chinese economy and how
might it affect us as investors in the United States? That’s a simple question
to ask but not an easy one to answer. The reason is that data out of China can
be somewhat opaque. However, we do know
there are some good data points to at least observe to get a better sense of
what may be occurring.
We can begin with the China Purchasing Managers Index
(PMI). PMI numbers help to explain whether the manufacturing sector (remember,
China is one of the world leaders in manufacturing), is expanding or
contracting. When the PMI reading is above 50, it indicates expansion and when
it is below 50, it suggests contraction. The last reported data from China was
for December and showed a sharp decline, a continuation of a trend that emerged
during the second quarter of 2018. With China’s PMI now below 49.5, it bears
GDP growth in China has also decelerated. However,
this is nothing new. In fact, since 2010, China has shown deceleration of GDP
growth which is to be expected. As the Chinese economy continues growing, it
becomes more difficult to post increasingly robust GDP growth numbers. That is
why for investors, the absolute year-over-year growth percentage in GDP might
be less important than the overall growth trend. That said, a GDP growth
slowdown in China has been a concern for some time and the added uncertainty
around the full impact of not having a trade agreement in place with the US
only adds to investor concerns.
Another important measure of economic performance for
China, and for any other major economy, of course comes from the corporate
sector. More specifically, the overall trend in earnings. Going back to 2012
corporate earnings growth in China flattened out in a trend that lasted through
2016. Since then however, earnings showed improvement. For example, Chinese
industrial companies showed profits up 8.4% in 2016, up 22.8% in 2017, before
another relatively strong showing through the first three quarters of 2018.
From these three data points, it is apparent that the economic picture in China is somewhat mixed. And while data released earlier this week indicate some further stability in China’s economy as stimulus programs take effect, there remain questions about China’s credit markets and of course trade. Until these issues are resolved, or at the very least are given a path to resolution, global equities could struggle to move meaningfully higher. The reason is that anytime a global recovery has occurred in the recent past, it has been on the back of a Chinese economic recovery. It is of course possible that it will be different than past global recoveries, but with the size of the world’s GDP tied to China in some way or another, it appears unlikely to be any different this time around.
Lot of Moving Averages Are Being Tested
Recent messages have focused on major U.S stock indexes reaching overhead resistance barriers which could slow their January advance; or maybe even end it.
All of those major stock indexes remain below their 200-day averages; while their 50-day lines remain below their 200-day lines. That puts the onus on the bulls to push stock indexes high enough to reverse those negative trends. Yesterday’s stock selloff suggested that the January rally might be stalling. This morning’s early bounce in stocks appears to be fading. That puts the market in an important testing process. The same is true of several stock groups. What they do with those resistance lines may help determine the direction of the market as a whole. Let’s start with some 200-day averages.
Chart 1 shows the Consumer Discretionary SPDR
(XLY) meeting new selling at its 200-day average (red line). That’s an
important test for that economically-sensitive sector. Chart 2 shows the Biotechnology
Index ($BTK) struggling to stay above its 200-day line. Looking
overseas, Chart 3 shows Emerging Markets IShares (EEM) struggling
with overhead resistance formed at its early December peak and its 200-day
average. Emerging market stocks have led the January rebound in global stocks.
What EEM does from here may help determine if that rebound runs into trouble.
Transports and Energy Stocks Slip Below 50-Day Lines – Small Caps
May Be Next
Some stock indexes are in danger of
slipping back below their 50-day lines. Chart 4 shows the Dow
Jones Transportation Average falling
back below its 50-day average (blue line) in today’s trading. The transports
are one of the most economically-sensitive stock groups, and helped lead the
fourth quarter meltdown. New selling in that group would be a negative sign for
stocks. Energy stocks are also weakening. Chart 5 shows the Energy
SPDR (XLE) trading
below its 50-day line today. Weaker oil prices are the main reason why. And
weaker oil prices are a sign of weaker global demand. That’s another potential
negative for U.S. stocks. Small caps may be the next group to fall below their
50-day line. Chart 6 shows the S&P 600 Small Cap index sitting right on its 50-day line. A close back
below that resistance line would be a negative sign for that group, and large
cap stocks as well. That’s because large caps usually follow the direction of
smaller stocks. Semiconductors are
also in danger of falling back below their 50-day average.
Early Bounce In S&P 500 is Fading
Stocks are at an important chart
juncture. Chart 8 shows the S&P 500 backing
off from overhead resistance formed between its October-November lows and its
early December high. It also remains well below its 200-day average (red line).
Chart 8 also shows its 9-day RSI line (upper box) backing off from overhead
territory at 70. After opening higher this morning, the stock rally appears to
be fading. Chart 8 shows the SPX sitting right on its 50-day line (which is
declining). Last week’s move above that resistance line was an encouraging
sign. A close back below that blue line this week would negate that positive
short-term signal. And would strengthen the view that the January stock rebound
is starting to weaken.
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