It’s been over a week since the market took it’s first deep dive that rattled investors and has fueled an unprecedented level of turbulence. If you’ve been listening to the media coverage, you know well that the primary cause of the new volatility is not the U.S. economy or a slump in a major sector, but a foreign country: China. The big question for many is this: why China?
It’s a complex question, but it’s rooted in the common misconception that the U.S. market is shaped solely, or at least predominately, by what happens within our domestic borders. As the world’s largest economy, we have a bit of hubris about our control over global economics when, in fact, there’s a whole lot more at play.
When it comes to China, we’re talking about the world’s second largest economy. The country’s accelerated growth over the past decade has had a huge impact on the world economy. Its emergence as a new economic superpower and its growing population have influenced growth strategies for companies in every market sector. The assumption for some time has been that China’s momentum would continue and that growth would provide a reliable source of profit and capital in every sector — manufacturing, technology, commodities and more. For U.S.-based companies looking to expand globally, China has been a logical target for growth. Steel companies upped exports to China to support its growing infrastructure. Auto manufacturers both exported and built new factories in China to feed demand. Technology firms took a similar approach, upping their focus on the region in anticipation of steadily increasing demand.
But then China’s slowdown hit. With a marked decrease in domestic growth, China’s businesses and consumers are experiencing significant fiscal constraints. The resulting decrease in spending has reduced the demand for goods from the U.S. and other countries — which directly impacts revenues for companies like Apple, Amazon and Yahoo and translates into lower P/E valuations, lower stock prices and worried investors.
The strength of the U.S. dollar against foreign currencies also weighs in to the picture. When the dollar is strong compared with other currencies, U.S. exporters receive less net revenue when paid through the form of a foreign currency, causing revenues to fall. In a stable global economy, this impact is relatively minor. We tend to focus on the strength of the dollar when we’re planning a trip abroad, but it’s not often a major concern for investors. But when a major currency like the yuan experiences a major decline, this impact is heightened — a factor that has compounded already heavy losses due to the decline in demand.
Not long ago, this level of global interconnectedness was less pronounced. But over the past 15 to 20 years, technology innovations have truly made the world a smaller place. As companies in every developed country increase imports and exports from their global trading partners, changes in the global supply chain have a much greater power to cause disruption. This past week, that disruption was deeply felt.
The good news? Despite the volatility, no one is anticipating a long-term impact on the U.S. economy or the market. Here’s why:
- The market remains in “correction” territory. A bear market occurs when declines amount to 20% or larger. To put that into perspective, remember that the market dropped more than 56% in 2008. The current drop of 12.5% is still well within “correction” margins. It’s been almost four years since the U.S. stock market has had a significant correction. Considering that corrections typically happen about once a year, many analysts are viewing this as a healthy and much needed market correction — nothing more, nothing less.
- The U.S. is not overly dependent on Chinese imports. While countries that export heavily to China — Canada, Brazil, Australia and Germany — are vulnerable to China’s decrease in consumption, the U.S. is in a very different situation. Why? First, exports comprise only 13.5% of our GDP, making the U.S. economy much less dependent on demand from China. At the same time, U.S. consumer spending is about 70% of GDP, which is unique in the world. As far as U.S. exports, China ranks fourth in the list of biggest importers of U.S. goods, behind Canada (19%), the EU (17%), Mexico (15%) and then China (7.6%), a fact that further insulates our GDP from a decrease in exports to China.
- The U.S. economy is continuing to grow at a steady pace. The second quarter reports that came out late last week demonstrate continued economic momentum. The nation’s output of goods and services expanded at a 3.7% annual rate in the second quarter — much faster than the 2.3% rate initially estimated last month by the Commerce Department. Also, consumer spending nearly doubled compared to the first quarter and analysts expect the trend to continue due to lower oil prices and steady gains in jobs.
So yes, China is in economic trouble. It’s a global heavyweight that’s down on the mat. And because China’s fall has a ripple effect on the economies of every country with which it trades goods and services, that fall inevitably impacts the U.S. stock market. That said, China is only one piece of a large and complex puzzle. Regardless of what happens within its own borders, the U.S. economy — and U.S. investors — remain poised for growth.
Still have questions about China, the market or your own portfolio? Let’s schedule a time to talk. I’m always here to help.