China almost saved the day back in 2009 when it embarked on a massive fiscal stimulus program. That created a surge in global growth, and with it the global stock markets and commodities grew.
But things can go to extremes before correcting. The price to be paid for that growth was higher inflation. Their real estate market started to bubble, and as in the US some questionable lending practices helped overheat it. In China the boom since 2009 has been fueled mostly by bank lending and rising property values. As bank lending surged, so did the growth in the money supply. And inflation followed.
When the central government stepped to rein control lending in order to bring down inflation it initially seemed manageable, as long as economic growth remained high. In China a good stable growth rate is above 8 or 9% which is of course too high for other developed countries. They need this as more poor citizens begin to join the middle class and move to the cities. This growth is at risk especially if property values start to decline, as they appear to be doing.
So far inflation seems to have rolled over. The CPI peaked at 6.7% a few months ago and is now down to 4.2%. This has given Chinese policymakers some breathing room to lower the reserve requirements to the banks again.
The U.S. economy has held up quite well; and there are good, albeit barely good, signs that things are improving. This fragile though. Economic growth is around 2%, jobless claims are below 400,000, the unemployment rate has fallen to 8.6%, retail sales have been OK, and inflation is low. It’s not great but better than the situation in Europe.
Company earnings continue to come in good, and if you believe S&P 500® Index earnings estimates for next year (over $100/share), then valuations are reasonable in the low teens. The U.S. stock market has outperformed other global stock markets.
It does not mean that the United States is out of the woods by any stretch though. The economy continues to face stiff headwinds: worsening demographics, high deficits, and a poor debt to GDP ratio of our own. Household delivering is taking place as people lower their personal debt, unemployment is a problem, and austerity at the state and local government level is in vogue; then a political system that seems unwilling to tackle the issue of America’s deficits and unfunded liabilities exists. Demographically, 78 million baby boomers will be looking for their benefits when they retire.
On top of that, the housing market continues to be weak and hold back the economic recovery we need adding to household deleveraging efforts. Eventually the housing market will recover about the time demand catches up to supply, or supply falls down to demand.
So for the US it could be more of the same too; with stocks generally making little headway as far as a trend is concerned. This likely means more choppy price action and volatility as headlines on al these issues emerge.
U.S. stocks could probably be expected to outperform Europe and emerging markets again as they did in 2011; but out performance could be on a relative basis and not show good gains year over year. The dollar could strengthen further with continued trouble in Europe, and commodity prices could weaken if China continues to slow down.
Should China not slow and Europe move towards a solution stock prices would have reason to improve.
We can be thankful that the U.S.equity market held its own through one of the most uncertain periods in recent memory in 2011. Its resilience was a testament to supportive fundamental factors that were often overlooked in the face of scary sounding global headlines and a testament to the embedded premium it enjoys being the largest and most liquid market in the world.
It is hoped that you can be thankful for good health, just as you may have been at the beginning of the year. Happy New Year!
Always, Trade with a plan.
Excerpts from Create Your Trading Plan by the writer