Less than is sometimes reported
We like to keep these notes short, but that might be a challenge as Greek turmoil, the China crash, and renewed commodity weakness casts doubt on our positive outlook for the world economy. Jumping to our conclusion—these are somewhat unrelated market moves that have little to say about the economic health of the major world economies. Here’s our thinking:
While the US stock market is far from the center of the current storm, we think the contrast between two memorable bear markets here in the US might help us to understand what’s happening around the world.
To put the question simply—is this 1987 or 2008? Those two years represent two very different bear markets. In 2008, the crash in stocks signaled the beginning of a major recession in the US. On the other hand, the crash of 1987 told us next to nothing about the economy at that time and no recession followed what was clearly just a stock market event.
First China: The collapse in the Chinese stock market has been the most nerve wracking since it confirms in the minds of many that the Chinese economy is about to hit the wall. We think it’s 1987 in China. A few facts:
- Fewer than 7% of Chinese citizens own stocks and those holdings are miniscule when compared with real estate, the primary form of wealth in China.
- There are two Chinese stock markets. One is similar to the Dot.com stocks here—lots of hype and no earnings. The other market is the banks and large companies that make up most of the market capitalization in the indexes and never participated in the run-up that preceded the crash. Margin calls of the speculative stocks force selling of the real businesses.
- The stocks of the “real” companies trade in Hong Kong as well as Shanghai. The PE ratio in Hong Kong is 12 and the yield is 2.9%—no bubble here.
Stock speculation got out of hand in China, but the market remains up 70% from a year ago and up since the end of last year. We need to watch the Chinese economy very closely, but so far this mess appears to be a stock market event not an economic one.
Next Greece: Three years ago markets where rightfully worried that if Greece left the Euro others would follow. Today the risk is reversed—if Greece stays in the Euro (with some debts forgiven and few real reforms), then the Italian and Spanish voters would want the same deal. Also, poorer Latvians and Bulgarians might be asking why they are being asked to bail out richer Greeks.
Greece is too small to have a major impact on the economy of the Eurozone. If Brussels can’t make a simple decision to separate themselves from Greece, while the current crisis will have passed, it will inevitably resurface in the future. Growth in the northern half of Europe is not threatened.
Last Oil and other Commodities: These markets have resumed the downward trend that began three years ago in metals prices and one year ago for oil. In the past, commodity prices sometimes signalled periods of economic growth vs weakness. In fact, the copper price was so good at this that some regarded “Dr. Copper” as the world’s greatest economist.
We believe the weakness in commodity prices is a result of massive investments in mining and drilling to satisfy the demands of Asia over the last fifteen years. Those investments have produced surpluses of nearly every industrial commodity, driving down prices.
Commodities are signalling a period of abundance not economic weakness. That’s actually a positive for the rest of the economy—the users of commodities.
Major bear markets are caused by recessions and for the reasons outlined above we do not expect a recession in any major economy. A continued correction in stocks prices? Yes, that can happen, but something bigger and nastier is unlikely.
Daniel A. Ogden