China Uninvestable

Stocks opened lower today on weaker economic data, but quickly reversed. At the moment the Dow is up 170 points and the S&P 500 is up .3%. Why? Setting aside the global economy for a moment, stocks are up today because oil and interest rates are down. Crude oil plunged below $89/barrel and copper fell more than 1% on soft China data (see below). Bonds rallied, pushing yields lower, on the realization that US economic growth is slowing.

The New York Fed’s manufacturing activity index declined far more than expected this month. In fact, this is the second-worst monthly dip since data began in 2001. About 43% of New York factories reported weaker business conditions. New orders declined, suggesting the weakness will persist for at least another couple of months. This report corroborates the narrative that consumers have shifted spending away from goods and toward services. Unfortunately, this shift comes at the same time that supply chains are beginning to function more normally. So it looks like inventories are too high all the way from factories to retailers.

The National Assn. of Home Builders’ sentiment survey also tanked this month. Confidence among homebuilders is now at its weakest level since the housing crash in 2007. Persistently high home prices combined with high construction costs and rising mortgage rates are beginning to take their toll. But there is some good news. About 1 in 5 survey respondents reported lowering prices in order to sell new homes.

China is becoming a problem for investors again. Where to start? Over the weekend Barron’s reported that China identified 35 people infected with a “novel virus that probably spread from animals to humans. The virus…is unrelated to the coronavirus.” Apart from that, a trickle of standard Covid cases threatens more draconian restrictions under the country’s zero tolerance Covid policy. Next, the slow motion property market crash in China remains a concern. JP Morgan analysts believe profits among Chinese real estate developers fell roughly 30% during the first half of the year. This, combined with high debt loads renders many of these companies financially vulnerable. In the past, investors could rely on government bailouts to prevent bankruptcy and debt payment defaults. But not so these days. The government appears increasingly willing to let over-extended developers default on debt payments, leaving investors holding the bag. The resulting loss of confidence in the sector is driving down stock and bond prices, and home sales are down 31% over the last seven months. Finally, China’s economy is slowing rapidly, enough that the central bank just cut interest rates. Retail sales, industrial production and fixed-asset investment all slowed unexpectedly in June.