Why China’s Growth, Or Lack Thereof; Matters So Much — Bret Jensen

Why China’s Growth, Or Lack Thereof; Matters So Much 2 comments

Jan 4, 2016 5:07 PM

The markets had their worst opening day to start a year Monday since 1932! This was the year before FDR came to the White House, the year the New York Times won its second Pulitzer for describing what a “worker’s paradise” this guy Stalin was building in Russia and the year before Adolf Hitler became Chancellor of Germany. In short, it has been a long time since we have had such a down start to an investment year.

There were two main triggers to the large sell-off to start off 2016 with a bang. First, the rift between Saudi Arabia and Iran escalated to a new level even after the two countries have been fighting a proxy war for years most notably in Yemen for many months now. The cause of this tension was Saudi Arabia executed a prominent Shiite dissident leader and several dozen other convicted extremists. Saudi Arabia’s consulates were then ransacked in Iran’s two largest cities. This caused Saudi Arabia to suspend commercial and diplomatic relations with Iran for the first time in decades.

Crude oil initially spiked some four percent on this new source of turmoil in the Middle East. However, after new readings continued to show a glut of inventory at the key transit hub of Cushing; crude gave up all of those gains. This shows how hard it might be to get a sustainable rally in energy in the early part of 2016. In addition, oil prices also reflected the larger trigger to the big decline to begin 2016 which was increasing concern about slowing growth and demand in China.

China’s GDP

China’s market was halted overnight on Monday as their main stock indices fell limit down seven percent. This was the bigger trigger for the opening decline in our markets to start 2016. At this point, I think it is fairly obvious that the Middle Kingdom is not growing anywhere near the official seven percent GDP levels. I have seen opinions speculating that real growth in China is nearer to two percent at the moment despite authorities’ best efforts to boost the economy and intervene in the equity markets. My own opinion is China’s GDP growth is more in the four to five percent range at the moment. The Chinese Yuan fell to four year lows in trading against the dollar today as well.

Turmoil in China was the major driver behind the correction our markets went through last summer and another similar event cannot be ruled out for 2016. The fact that oil, copper, iron and other commodity prices are multi-year and in some cases decade lows speaks to the slowdown in Chinese growth to a large extent.

China is trying fervently to migrate to a more consumer driven economy as it has been quite evident that the country has a glut of manufacturing capacity even as it loses competitiveness against lower cost manufacturing countries such as Vietnam. This is not going to be an easy transition for China and it will play out over many years.

I think it is important for investors to differentiate between China’s manufacturing economy and its consumer economy. The former will probably struggle for years with its overcapacity while the consumer part of the economy should weather this transition on firmer footing. This is one reason I am completely out of both the energy & commodity sectors as I think the bust in those areas has to have one big “washout” before it is investable. I would also avoid industrials like Caterpillar (NYSE:CAT) and Joy Global (NYSE:JOY) that count on China and commodity demand for a good portion of their demand.

The consumer part of Chinese economy should hold up much better. This is one reason I have added to my stake in Apple (NASDAQ:AAPL) recently on its ~20% pullback. The tech giant from Cupertino is seeing the majority of its growth come from the Middle Kingdom and this should continue to be the case with no signs demand for its iPhones is ebbing in China. At less than 10 times forward earnings, a huge cash hoard and a two percent yield; the stock is cheap here.

In addition, General Motors (NYSE:GM) and Ford (NYSE:F) are good value picks at less than eight times forward earnings with ~four percent yields. Auto sales are starting to pick up in China after a lull through most of 2015. Overall auto sales in China are just a bit more than United States despite having roughly four times the population which bodes well for future robust sales growth.

If one ones to sidestep the whole conundrum around what the growth level of China actually is to avoid anything that depends on China altogether. Large biotech stocks like Amgen (NASDAQ:AMGN) and AbbVie (NYSE:ABBV) should continue to show solid revenue and earnings growth in 2016 even as worldwide growth levels remain anemic, sell for less than overall market multiple and pay solid dividends to boot. I plan to pick up additional shares in both should the rough start to 2016 continue in the week ahead.

That is my take this first trading session of the New Year.

Bret Jensen

Thank You & Happy Hunting

Bret Jensen

Founder, Biotech Forum

Disclosure: I am/we are long AAPL, ABBV, AMGN, F, GM.

Originally published at seekingalpha.com.

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