Stocks shrugged off disappointing news from China and the Empire state to rally as hopes of peak Fed hawkishness drove buying. The housing sector continues to weaken according to the latest numbers from the National Association of Home Builders.
Good fortune / bad fortune. Whether you reside in the US or not or whether you like the US or not, if you own US-based stocks your economic fortunes are…well, largely tied to what happens in the US. This would seem to be somewhat of a blinding glimpse of the obvious, but many of us, whether we like it or not, have learned in the past few years that there are some strong forces NOT IN THE US that can materially impact the US stock market.
The US is a net-importer. That means that we buy more from foreign countries than they buy from us. I am sure that you have heard of the trade deficit. It has from time to time become a political issue that existed far before the US-China trade war that was kicked off by President Trump in 2018. There have been many contentious passages between the US and its foreign trade partners. Sure, it can get a bit political, for obvious reasons, but there are economic impacts as well. Right now, the US economy is in sharp focus as investors wonder whether this technical recession will turn into something bigger and more painful, rightly so. That is why I have dedicated so much of your time and my ink to the discussion. Those discussions have largely been focused on (my favorite) consumption, and business investment (my second favorite). Consumption, because it makes up the bulk of the economy and is largely driven by sentiment, and business investment made by businesses which are rational (I mean that in the economic sense), meaning that they will respond rationally to economic conditions investing more when things are good and pulling back when the economic climate starts to look menacing. But, what about that trade deficit?
GDP, or gross domestic product, covers all product produced (or consumed, depending on how you look at it) within the border of a country, in the case of today’s discussion, the United States. Therefore, net resources flowing out of the borders (trade deficit) reduce GDP. The actual deficit number bounces around a bit, but ultimately, the net number is small enough to be ignored…until it isn’t. Let’s go back to why the US is considered to be in a technical recession. That is because the US has had 2 consecutive pullbacks in GDP growth, Q1 and Q2 of this year. We know that the Q2 pullback was caused by weaker consumption, though still positive, and an actual -13.5% decline in business investment. That makes sense given the rapidly tightening financial conditions and rational pulling back by companies. But that is only one half of what caused the technical recession. In Q1, in which US GDP declined by -1.6%, consumption and business investment still grew at a respectable rate. It was Net Exports that threw the knockout punch. Wait W H A T? It’s true, imports surged in Q1 by +18% as result of supply chains easing up. Remember that is an outflow (or a drag) on the US GDP. Adding insult to injury, exports fell by -4.8% due to the start of the Ukraine war and the onset of trade restrictions. That means less inflow to the US economy, which adds to the outflow surge. The result was a decline in overall GDP growth. Now, that number is typically negative, but not nearly as big. The good news, which I hope you have already concluded, is that those conditions are somewhat anomalous. A war and a reemergence from a once-in-a-generation, pandemic lockdown, supply chain logjam, don’t come every day, or quarter. In fact, in Q2 exports grew by +18.0 while imports only rose by +3.1% which actually benefited GDP growth, though not enough to keep the overall figure in the green.
Yesterday morning, economists were somewhat taken by surprise when they read, clad in pajamas, that China had missed the mark in factory production and consumption. More surprising was that the PBOC (Peoples Bank of China, the Chinese central bank) lowered its key lending rate, for the second time this year. “Wait Mark,” you exclaim, “doesn’t the stock market like rate cuts?” Yes, indeed, the market does like rate cuts…in the US. A rate cut in China, or any US trade partners is the result of a weak economy. If China’s economy is growing weaker, that could lead to lower US exports to China as Chinese companies and consumers purchase less US goods. Despite common misconception, there are many US companies that derive revenue from Chinese consumers and companies. The usual suspects are industrial companies which have supported Chinese explosive infrastructure growth; companies like Caterpillar, Honeywell, and Emerson Electric, to name but a few. But there are others, some of your favorites, that also rely on spending from Chinese consumers. Apple, Netflix, Disney, Tesla, and General Motors are all reliant on Chinese consumption for growth. Does that spell bad news for these portfolio favorites? Not necessarily. A leading cause for the economic contraction in China is its Zero-COVID policy in which draconian lockdowns have literally tamped down both production and consumption. That means that if the pandemic lets up, or the government eases its policy, those contractive conditions can clear up. But there is a good news / bad news scenario as well. China is the second largest consumer of crude oil in the world (behind the US). Being an industrial country, when its economy contracts, there is correlation to global demand for crude. In other words, the lower demand for crude oil will push its price down. Good news for US inflation as we have witnessed lower prices at the pump. China is the top global consumer of corn, wheat, soybeans, potash, pork, steel, copper, and silicon. All these commodities have played a big role in the current state of global inflation. Less demand for them will certainly allow prices to moderate, which is a good thing for us all. Unfortunately, it will likely have a negative impact on the many US companies that rely on China as a customer. Think it’s all about the US? Think again.
YESTERDAY’S MARKETS
Stocks gained ground once again yesterday as weak economic numbers from China and the US gave rise to hopes of a less aggressive Fed. The S&P500 gained +0.40%, the Dow Jones Industrial Average climbed by +0.45%, the Nasdaq Composite Index rose by +0.62%, and the Russell 2000 Index advanced by +0.23%. Bonds rose and 10-year Treasury Note yields fell by -4 basis points to 2.78%. Cryptos slipped by -1.33% and Bitcoin pulled back by -1.02%.
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