The Truth and Worldwide Risk
Behind China's Big Slowdown

By Michael Lombardi
July 26, 2013

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Troubles in the Chinese economy are mounting as the economic slowdown in the world's second-biggest economy takes its toll -- troubles that could wash ashore here in North America sooner than most expect.

The Flash China Manufacturing Purchasing Managers' Index (PMI) registered at 47.7 for July -- a new eleven-month low. (Source: Markit, July 24, 2013.) Any reading below 50 on the PMI represents contraction in the manufacturing sector.

The Chinese economy is heavily focused on manufacturing, so a contraction of this magnitude indicates a severe economic slowdown for the country.

And that's not all...

Gross domestic product (GDP) for China's economy is quickly slowing. After growing for years at 10% per annum, in the first quarter of this year, China's economy grew at only 7.7%; in the second quarter, the rate slowed further to 7.5%. (Source: MarketWatch, July 23, 2013.) Growth of 7.5% per year for the Chinese economy is embarrassing when compared to its historical average.

So why would an economic slowdown in China's economy be a problem for us here at home?

China's economy is the third-biggest destination for U.S. exporters.

As the economic slowdown in the Chinese economy strengthens, demand for goods and services within the country will decline. American exporters will face more downward pressures on profits as they export less to China. And U.S. GDP will get hit as exports are considered one of the major factors in its calculation.

But the damage the economic slowdown in the Chinese economy could have on American and Canadian exporters is just one small piece of the puzzle. Corporate earnings of U.S.-based companies operating in the Chinese economy will also become an issue.

Giants like Wal-Mart Stores, Inc. (NYSE/WMT) and Caterpillar Inc. (NYSE/CAT) have a major presence in the Chinese economy. Wal-Mart operates 380 stores in China, employs 100,000120,000 people in that country, and has been opening 5060 stores a year in China.

Pfizer Inc. (NYSE/PFE) has a significant stake in the Chinese economy, with business operations in 250 cities and eight plants in three major cities. (Source: Pfizer China web site, last accessed July 24, 2013.)

As I have outlined in these pages before, the U.S. is not an isolated island. We are connected to events in the global economy. The economic slowdown in the Chinese economy will impact U.S. growth and the corporate earnings of companies on key stock indices.

Michael's Personal Notes:

In the first quarter's revised U.S. gross domestic product (GDP) numbers, we found consumer spending in the U.S. economy was slow, dragging U.S. economic growth lower. Going forward, I can't help but to expect more of the same.

We are already getting warnings from major financial institutions that U.S. GDP growth in the second quarter will be dismal. The Goldman Sachs Group, Inc. (NYSE/GS) expects the U.S. economy to grow at only 0.8% in the second quarter. The Royal Bank of Scotland Group plc (NYSE/RBS) and Barclays PLC (NYSE/BCS) both expect U.S. GDP growth to come in at 0.5%. (Source: Wall Street Journal, July 15, 2013.)

It shouldn't go unnoticed: consumer spending makes up about two-thirds of the GDP in the U.S. economy. If consumer spending declines, or remains stagnant, then it would be foolish to expect the U.S. economy to experience any growth.

Let's look at retail and food services sales, a key indicator of consumer spending in the U.S. economy. Since the third quarter of 2009, the average rate of growth quarter-over-quarter in real retail and food services sales in the U.S. economy has been 0.9%. In the second quarter (April though June) of 2013, these sales only increased 0.81% from the previous quarter. (Source: Federal Reserve Bank of St. Louis web site, last accessed July 24, 2013.)

Unemployment -- another indicator of pressure on consumer spending -- remained a problem throughout the second quarter. While the mainstream media and politicians told us everything is great on the employment front, the reality was quite the opposite.

In the U.S. economy, the underemployment rate, which provides a better look at the U.S. labor market situation, actually increased from 13.9% in April to 14.3% in June of 2013. (Source: Bureau of Labor Statistics, July 5, 2013.) It's common sense that when people don't have jobs, they pull back on their spending.

Aside from a slowdown in retail and food services sales and rising real unemployment, the U.S. housing market remains depressed, as real homes buyers stay away from the market. Right now, we have institutions fueling home purchases. First-time home buyers fuel the economy as they buy lawnmowers, appliances, and furniture to fill their homes. Recently, I've heard stories of big institutions buying homes in bulk (to rent out) and filling them with appliances they are buying directly from overseas in bulk.

All this happened during the second quarter of 2013, as the key stock market indices continued to rally.

In the first half of this year, key stock indices like the S&P 500 rose roughly 13%. Is this sustainable when the U.S. economy is struggling? I seriously doubt it.

Sure, markets can stay irrational for longer than most expect, but eventually, regression to the mean occurs. And when it does, it won't be a pretty sight.



Originally posted at Profit Confidential

(c) Michael Lombardi, MBA

 

 

 

 

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