Throughout the steep recession in the United States that has since spread to the rest of the world one common ray of hope was China. China’s GDP had been growing at a brisk 12 percent per year, and as its population prospered into a middle class lifestyle, demand for foreign, especially U.S., goods and services exploded. This demand, in part, bolstered the boom in commodities that ended last Summer in classic bubble-bursting fashion. Still, commodities were expected to bounce back quickly because the Chinese economic engine was humming along despite the financial crisis. That is no longer the case, and the consequences for economic recovery in the U.S. and elsewhere are dire.
China in Decline
On January 22, 2009, China reported its GDP for the fourth quarter of 2008. The following is a recap of the information the country provided, courtesy of RGE Monitor:
- China’s real GDP growth slowed to 6.8% in Q4 y/y, the slowest in seven years and a sharp slowing from 9% in Q3 as Chinese exports and manufacturing contracted and investments slowed. Chinese growth has been decelerating for six consecutive quarters and is unlikely to grow more than 4-5% y/y in 2009 as global demand for Chinese goods continues to be weak, investment continues to slow (despite government spending) and domestic demand weakens from job losses, negative wealth effect from equity and property market losses (RGE)
- On a quarter on quarter basis Chinese output was negative (an estimated -0.3% annualized- Citi), the first quarterly contraction in 16 years and a number consistent with the plunge in electricity output which is often used by economists as a proxy for growth. Indicators suggest Chinese growth will continue to contract o n a q/q basis again in Q109 despite a possible stabilization as inventories are worn off. Exports have fallen to a year-on-year growth rate of 2%-3%, Manufacturing (40% of GDP) has been in contraction since August, FDI and fixed asset investment have been on a slowing trend.
- Estimates for 2009 growth are being rapidly revised down to a 5-7% range from 13% in 2007 and 9% for all of 2008. The IMF suggested it could halve to 5%. Others suggest that negative growth is not out of the question.
While 6.8 percent growth may seem like good news, for an emerging market like China, it is not. With approximately 24 million workers entering the market each year, China needs a minimum growth rate of 9-10 percent to provide jobs to those workers. Thus, a 6.8 percent growth rate will feel like a recession to China, and if it’s growth rate continues to fall, China will experience a recession in real terms as well. Anyone interested in more on this subject should read Nouriel Roubini’s article here.
A Chinese recession will be devastating to the U.S. as it tries to scratch its way out of a deep recession (if not a depression – not the Great Depression, but a standard, textbook definition depression). Prices of commodities will continue to slide, the U.S. will not have a strong trading partner in China upon which it can lean for economic activity, and the U.S. may find itself without one of the largest buyers of its debt, in the form of U.S. Treasuries.
As of November 2008, China held approximately $682 billion of U.S. Treasury securities. That is 22 percent of total foreign ownership of U.S. Treasuries, making China the largest foreign holder of U.S. debt. With the total U.S. public debt running to approximately $10.6 trillion, China holds roughly 6-7 percent of the total in the form of U.S. Treasuries.
The job of turning around the U.S. economy just became much more difficult.
Investing Implications
There is no reason to be in equities for the intermediate- or long- term. The S&P 500 will most likely drop to 700, and it may fall far below that to 600, or as some have predicted, 500. Regardless of what the ultimate low is, no one should be invested heavily in equities for the time being.
On the fixed-income side, one should beware U.S. Treasuries for two reasons: (1) they are overbought, and that has driven yields to zero or near-zero; and (2) if demand slacks as China and other countries stop buying U.S. debt, prices on Treasuries will crash.
Treasury Inflation-Protected Securities (TIPS) are very attractive right now because the new issues are pricing in very low to no inflation. While the U.S. will likely experience very low inflation or possibly some deflation in the next year to two, over a ten-year period inflation is almost certain to return as the monetary policy and stimulus packages will reignite the economy and inflation someday.
Highly rated investment-grade corporate bonds are also a safe place to put one’s money to work, but only highly-rated debt, and one should be sure that the company has low debt and reasonable growth prospects.
Stay safe!
Economic Impact of Fiscal Stimulus Plan as Proposed
Posted by greggkilloren on January 28, 2009
The future is never certain—that is what makes forecasting so much fun and investing so dangerous. We seem to find ourselves at a crossroads, one of many we have already faced, with more sure to come. The announcement out of Washington, D.C., of a new economic stimulus plan has the stock markets up for a fourth consecutive day—something not seen in months. Is this excitement warranted? In other words, should we put all of our money back into equities? The best answer is to be hopeful and optimistic about the future, but not with your money, at least not yet.
In a conference call, entitled “Fiscal Stimulus Plans and Implications for the Economic Outlook,” hosted by Goldman Sachs Investment Strategy Group on January 28, 2009, two Goldman Sachs’ economists analyzed the proposed $828 billion fiscal stimulus plan that is currently being considered by Congress. The call was moderated by Sharmin Mossavar-Rahmani and featured commentary by Alec Phillips, Washington Economist, Goldman Sachs Global Investment Research, and Ed McKelvey, US Economist, Goldman Sachs Global Investment Research.
In my view, three major themes emerged from the discussion:
Structure of Stimulus Package
Much of the equity market excitement in the package is due to infrastructure spending. However, only 15 percent of the total package is allocated to such stimulus. The other portion of the package that has the markets buzzing, new technology (alternative energy) and information technology spending (especially healthcare-related IT) is only 10 percent of the package. Nearly 60 percent of the total is dedicated to tax breaks and state assistance.
The tax reductions include reduced withholding taxes for personal income. Thus, in each paycheck over the course of the year, workers will receive more of their income as take-home pay. This is considered a better alternative to sending rebate checks, like those in 2008 which were more or less saved or used to pay down debt, because workers will perceive income growth by receiving the benefit over time and may be psychologically more inclined to spend. One problem with this idea is that it requires one to be employed to receive the benefit, whereas the rebate checks were based on income thresholds and the filing of tax return. With the multitude of layoffs announced this week and in the past couple of months, the benefit of reduced payrolls taxes in the short-term may not be very stimulating.
The other tax reduction benefits businesses by offering bonus depreciation for assets and certain tax refunds.
Timing Limits Impact
Of the proposed $828 billion, only $218 billion is scheduled to be spent in 2009. In 2010, another $357 billion would be spent, with the remaining $254 billion coming between 2011 and 2018. Thus, our expectations for economic recovery must be tempered by the fact that the impact of the stimulus plan will be felt until next year and the years beyond. We can look forward to an end of the decline in asset prices within the next 12 months and a steadying of the economy, but we must not expect a return to prior economic growth rates and rapidly rising standards of living.
Private Sector Demand Destroyed
Personal savings rates have risen dramatically in the aftermath of the credit crisis, as has been noted in sharply reduced consumer spending and borrowing data. Businesses are following the same path and largely for the same reasons. This is expected in recessions. What is different this time, is that private sector spending, consumer and business, will not pick up where it left off in the coming years.
Phillips and McKelvey made the following observations:
Because private sector spending will not resume at the previous rate, and the other usual leader out of a recession, investment in housing, is likely going to be dormant for several years, the government will need to fill the spending gap. Therefore, while the new fiscal stimulus program is encouraging and should offer us reason to look forward to the future, it will likely not be the last stimulus program.
Posted in Investing, Market Commentary, Personal Finance | Tagged: Economy, Fiscal Stimulus, Market Commentary | Leave a Comment »