Slowing economic growth in China has investors concerned there could be a spillover effect around the globe. China’s manufacturing growth recently slowed to an eight-month low, indicating further easing in the world’s second largest economy. The bigger picture shows China’s GDP expansion headed toward 7.0%-7.5% in 2014, a bit less than the past couple of years, and notably lower than the pace of the past decade. Stocks of companies, including Freeport McMoran (FCX) and BHP Billiton (BHP), whose fortunes rely on demand for commodities, such as copper and coal, have traded below their peaks in the commodity cycle as a result. The price of copper has fallen moderately in 2014 as a result of the slowdown in China, the world’s largest consumer of the industrial metal. The concern is that China’s consumer economy is not accelerating quickly enough to take the place of slowing manufacturing exports.
There is a lot at stake regarding the health of emerging markets as to how quickly China expands. China buys an enormous amount of raw materials from countries in South America, Africa, Asia, and the Middle East. If those purchases were to further slow, a number of emerging market nations would have less cash to spend on imported goods from China and the United States, potentially creating a down cycle.
These worries may well be short-term in nature, but that is Wall Street’s way. On the plus side, China is already the largest economy in Asia and on its way toward challenging the United States for global dominance in business within a decade or two. Naysayers hold that China could be another Japan, and stagnate for years. But China’s teeming population remains eager to enjoy a level of prosperity nearer to Japan’s on a per-capita basis, suggesting the comparison to Japan may not hold.
In fact, some cooling off might be good in the long run, allowing for a more sustainable pace of growth. The People’s Republic of China has come a long way in a relatively short period of time, with initial reforms following the 1976 passing of Chairman Mao allowing farmers to keep the excess they produced after meeting government quotas. Those baby steps had turned into enormous strides in an economy showcased for the world by the time China hosted the 2008 Summer Olympics.
But there was a price to be paid, in the form of environmental damage and rising debt from overbuilding. Air pollution from the sprawling industrial complexes constructed to power China’s booming exports became rampant, making the slower growth nowadays a welcome alternative to many with its less harmful environmental effects. Moreover, the construction of entire cities, still sparsely inhabited, contributed to a debt burden that is now crimping the government’s ability to finance initiatives to the same extent as it did in the 2008-2009 global financial crisis, when China bucked the downtrend and posted 8.7% GDP growth in 2009.
China is nevertheless taking moderate steps to reinvigorate growth, such as investing in high-speed railways and low-income housing, while making sure consumer credit is readily available. A loosening of exchange rate controls has also allowed China’s currency to depreciate somewhat, helping manufacturers. Overall, our assumption is that China has sufficient incentive to maintain a healthy rate of expansion that will enable it to produce enough jobs for its one billion-plus population. Steady economic growth and job creation is vitally important to the government, since it aims to avoid social unrest.
Of course, how forgiving investors are of a less robust rate of expansion remains to be seen. It will likely come down to whether or not China materially slows below the official GDP target of 7.5%. But, even if China’s growth were to slow more than expected, investors ought to recall that the United States stock market continued to do well even after Japan, then the world’s second largest economy, faltered in the 1990s. If sufficient growth were to arise elsewhere, such as the so-called MINT (Mexico, Indonesia, Nigeria, and Turkey) nations, and from up-and-coming countries, including Poland, investors might be less concerned about China. And China’s economy could still surprise on the upside if growth in the United States accelerates, as anticipated, and stateside consumers purchase more of China’s manufactured goods.
At the time of this article, its author did not have positions in any of the stocks mentioned.