If you really wanted a reason to sell stocks, China gave you one on the first trading day of 2016. But jumpy investors might be looking too hard for bad news.
A gauge of Chinese manufacturing activity dropped slightly in December, which financial markets interpreted as a calamity. Stocks plunged across China Monday, triggering newly installed “circuit breakers” meant to halt trading during violent selloffs. Traders described the rout using words such as “panic,” “stampede” and “unprecedented.” And with a temporary lockup on selling by some holders about to expire, the China wipeout could get worse before it gets better.
So China must be plunging into a recession, right? Or collapsing like a house of chopsticks? Actually, no. “The underlying problems are there,” says economist Nicholas Lardy of the Petersen Institute for International Economics. “But I don’t think it’s a cause for as much alarm as some people are saying.”
Traders pay close attention to China’s industrial sector because that’s where the data is. Reports on industrial output come out monthly and include detailed numbers on many different sectors. That’s in line with China’s modern history as “the world’s factory” -- a nation that rose to prominence by building stuff mostly exported to other nations.
But China has been evolving into a consumer economy, more like the United States, that depends increasingly on consumer spending by its own citizens who are growing wealthier. China’s national income per capita, at about $13,000, is still about one-fourth that of the U.S., according to the World Bank. But the bank now classifies China as an upper-middle-income country, comparable with Malaysia, South Africa and Turkey. The U.S. and western Europe are just one tier higher.
As consumers become more affluent, they spend more on services like tourism, entertainment and education, which is what has been happening in China. The service sector now accounts for about half of Chinese GDP, while industrial activity accounts for just one-third. Yet China’s service sector is relatively new and still gets less attention than manufacturing. Rather than monthly government reports, there are quarterly ones, broken down into just five main categories.
China’s service sector, however, seems healthy, with one recent indicator coming in at the highest reading in over a year. “The financial community spends far too much time looking at the industrial sector,” says Lardy. “The service sector looks like it’s going to outperform.” And that probably says more about the health of the Chinese economy than old-school counts of smokestacks and assembly lines.
If you’re looking for problems, however, China’s industrial sector is where you’ll find them. The biggest concerns are sprawling, state-owned enterprises involved in commodities and construction. China’s real-estate market got overbuilt during the last five years, with the most inefficient firms taking on too much debt. Profit margins for some of those conglomerates are now dropping to 0 or worse. If real-estate values fall in 2016, which is a distinct possibility, some big firms could become effectively insolvent.
The thing is – none of that is new or surprising. Investors have been concerned about a Chinese property bubble for several years. The boom and bust in Chinese stocks in 2015—with shares soaring by more than 100% during the first half of the year, then falling by nearly as much during the second half—revealed the creaky, simplistic workings of a market still not up to global standards. Given all that, the Shanghai stock market still eked out a small gain for the year, beating American and European stocks.
Chinese stocks may still have further to fall, and the nation’s economy, once the world’s hottest, is clearly slowing down. Moody’s Analytics predicts GDP growth in China will fall from 6.9% last year to 6.4% in 2016. But the bigger problem may be what global investors see in China, rather than what's really there. The two aren’t necessarily the same.
Rick Newman’s latest book is Liberty for All: A Manifesto for Reclaiming Financial and Political Freedom. Follow him on Twitter: @rickjnewman.
