China & Fed Lift-Off Dominate Market Trends – Why? by Gary D. Halbert
FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
October 27, 2015
IN THIS ISSUE
- Is China’s Economy in Trouble? The Answer is Maybe
- China’s “Fifth Plenum” Gathering in Beijing This Week
- Fed Lift-off: Not Tomorrow, December Move Still Uncertain
- Advance 3Q GDP Report Expected to Disappoint on Thursday
- Is America Still #1 in the World? – Maybe Not, Unfortunately
Is it just me, or does it seem like the global markets are preoccupied with two things: China’s economy and when the Federal Reserve will raise US interest rates? Sure, there are other things going on, but these two topics seem to be driving the financial markets more than any others this year.
In that light, we will begin today with a look at China’s latest economic report last week which received mixed reviews among economists. While China’s economy is slowing, growth is still officially near a 7% annual rate. Even if it’s only 5-6%, as many believe, a recession is not likely in China anytime soon.
Following that discussion, I will touch briefly on the Fed’s policy meeting that began today and ends tomorrow. Most Fed-watchers, including me, don’t expect any surprises tomorrow, but you never know. On the subject of the Fed, there is increasing talk about short-term interest rates going below zero. I’ll briefly explain what that’s all about.
While China and the Fed seem to dominate the headlines and financial market trends, there is a very important report coming out this Thursday. That’s when we get the government’s first estimate of 3Q GDP. The pre-report consensus is at 1.7% with some estimates as low as only 1.0%. If correct, that means the strong growth in the 2Q (3.9%) did not carry over during the summer.
Finally, I will close out today’s letter by summarizing the most interesting article I read last week.
Is China’s Economy in Trouble? The Answer is Maybe
Last Friday at the end of the day, the People’s Bank of China (PBOC) cut its key interest rate for the sixth time in the last year. The move came as a surprise to many around the world since China had just announced that its economy grew by 6.9% (annual rate) in the 3Q, which was slightly better than the pre-report consensus of 6.8%. So why the need to cut rates yet again?
The answer is that the Chinese economy is not as strong as its communist leaders would have us believe. While most countries would kill for 6.9% GDP growth, that is the lowest level for the Chinese economy since a 6.2% reading in the 1Q of 2009 during the global financial crisis.
Many global forecasters believe that nominal GDP growth in China has slowed to 6.2% at best, and many believe it is even slower as I will discuss below. This is translating into weak cash-flow for many Chinese companies that already face high debt burdens.
China’s industrial sector has been especially hard hit, with the country’s northern rustbelt on the brink of a recession. And more than a percentage point of overall growth this year has stemmed from activity in the financial sector, a contribution that is falling away quickly in the wake of this summer’s stock market plunge.
As a result, many analysts now believe that China’s real growth is closer to 5-6%, well shy of the government’s 7% target. In addition, China has experienced three years’ worth of wholesale price deflation, and although we don’t hear much about this, it clearly is a drag on the economy. However, even if China’s growth is only 5-6%, that doesn’t suggest a recession anytime soon, as many have feared over the last few months.
Last Friday’s surprise interest rate cut was also accompanied by yet another reduction of banks’ reserve requirements for the fourth time in the last year. Big banks now must set aside only 17% of their deposits as reserves. This means that China’s banks now have more money to lend if they choose to.
By the way, all of China’s monetary policy moves are, strictly speaking, surprises. The central bank does not hold scheduled meetings, as most central banks do, and it often waits until the end of the day on Fridays to make big announcements, giving the markets time to digest the implications over the weekend.
This latest easing is also a reminder that the PBOC has actually been cautious thus far, leaving itself plenty of space if it wants to deliver more easing just ahead. Even after the succession of cuts this year, the PBOC’s one-year benchmark lending rate stands at 4.35%. Most analysts expect the central bank to continue to cut rates periodically into early next year, until it is satisfied that the economy has stabilized.
There have in fact been some tentative signs of improvement recently. Property sales have picked up of late, and that has begun to filter into more construction. A push for infrastructure investment has started to gain traction. Income growth and consumption, meanwhile, have so far remained resilient, showing little lasting impact from the recent stock market meltdown.
All that helps explain why China’s stimulus moves, both fiscal and monetary, have come in small doses over the past year and are likely to continue. Growth is slower than advertised, but the bottom is not falling out. Recession fears are overblown.
China’s “Fifth Plenum” Gathering in Beijing This Week
As you read this, China’s top brass are meeting in Beijing for the Fifth Plenary Session – a key four-day annual policy-setting meeting that will be closely watched by investors worldwide. As the name suggests, the Fifth Plenum is the fifth out of seven major meetings held by the Communist Party’s Central Committee, a political body that is made up of the Party’s top leaders.
The Fifth Plenary Session is typically highlighted by a new Five-Year Plan (FYP) for the country, which will include major economic, monetary and development goals and guidelines. The 100+ page document will contain both qualitative goals, such as “building a moderately prosperous society by 2020” as well as quantitative targets on economic, social and environmental issues.
This year’s FYP is the first to be produced under President Xi Jinping’s leadership and comes at a time when China’s economic growth is forecast to decelerate further. It also comes in a year when the Chinese government has already taken some unprecedented actions.
The Chinese government’s intervention in its stock market and the devaluation of the renminbi (yuan) this summer provided a loud reminder that economic developments in China affect everyone. And there is every expectation that China’s leaders will make more world-shaping decisions at this week’s meeting.
Two years ago at the Third Plenum, China’s leaders committed to pursue far-reaching reforms, declaring that markets must “play a decisive role in allocating resources.” While the government would continue to play the leading role in providing public goods and services, policymakers would “unwaveringly encourage, support and guide the development of the non-public sector and stimulate its dynamism and creativity.”
What this means is that China’s leaders are trying to reform and turn more control over to the private sector and the markets. Yet China certainly faces serious challenges this year with slowing GDP growth, rising internal debts, a depreciating currency and capital leaving the country in the wake of the stock market plunge this year. So it will be especially interesting to see what reforms and changes the Communist leaders adopt this week. Details to follow.
Fed Lift-off: Not Tomorrow, December Move Still Uncertain
The Fed Open Market Committee (FOMC) is meeting today and tomorrow in Washington. No decision to raise the Fed Funds rate is expected at this meeting. Chair Yellen does not have a press conference after the meeting concludes tomorrow afternoon.
Following the dreadful unemployment report for September (and the equally dreadful revisions to the August report) early this month, most Fed-watchers concluded that there won’t be a rate hike this year unless we see some very strong economic data between now and the last policy meeting on December 15-16. That remains to be seen.
What is interesting over the last month or so is the growing discussion of the FOMC taking the Fed Funds rate below zero in an effort to stimulate the economy. We have never seen a negative interest rate in this country, but this is happening in certain other countries around the world.
Most Americans have never thought about a negative interest rate. In essence, that means investors would have to pay to invest in, let’s say, government securities. That’s not likely to happen.
The most likely next step, if the Fed feels it needs to do more to stimulate the economy, would be to cut the interest rate it pays large banks that hold their excess reserves with the Fed. Currently, the Fed pays banks 0.25% interest on deposits they hold at the central bank.
US banks currently have over $2.5 trillion in excess reserves parked at the Fed. That’s $2.5 trillion that banks could be lending out to borrowers, if they were so inclined. For now, however, the banks prefer to earn a risk-free 25 basis-points by parking that money at the Fed.
If the Fed wanted to encourage banks to put that money to work, it could cut the interest rate to zero. If that didn’t work, the Fed could go to a negative interest rate – meaning the Fed would charge banks a fee on deposits held at the central bank.
If the Fed eliminated the 25 basis-point rate, or more aggressively, charged banks to hold their money, the banks would withdraw those deposits immediately in order not to lose money on their cash holdings. And, hopefully they would find better things to do with it, like making more loans, which would stimulate the economy.
I don’t expect this to happen, but since it’s being talked about, I thought I would bring it to your attention.
Advance 3Q GDP Report Expected to Disappoint on Thursday
On Thursday at 8:30 eastern time, we get the Commerce Department’s first estimate of 3Q Gross Domestic Product. The economy rebounded in the 2Q by a stronger than expected 3.9%, following only 0.6% in the 1Q.
It is widely agreed that the weak 1Q GDP number was largely the result of the severe winter weather this year, and that the much stronger 2Q performance was mostly a rebound from the anemic 1Q. But other forecasters believed that the strong showing in the 2Q would carry over into the 3Q (I was not among them).
The pre-report consensus for Thursday’s 3Q GDP report is only 1.7%. If correct, that will dash hopes that the strong 2Q growth carried over into the 3Q. If the 1.7% consensus is accurate, that will mean economic growth this year has averaged a meager 2.07% through the first three quarters.
Is America Still #1 in the World? – Maybe Not, Unfortunately
I’m one of those people who believes that America is still the greatest nation on the planet. Americans have long been fascinated with global rankings, and we like to imagine ourselves as #1 in the world. But a new report from the Organization for Economic Cooperation and Development (OECD) confirms that the US is #1 in some areas, but not in others.
The report, titled “How’s Life? Measuring Well-Being,” is compiled by the OECD every two years. It covers mainly wealthy countries, though a few poorer nations (Mexico and Turkey, for example) are also included. Some of the comparisons may come as a surprise. The actual article is the first link at the end of today’s letter. Here are a few highlights:
- The United States ranks #1 in average after-tax household income at apprx. $40,000. Norway is next highest at almost $35,000. Among the 29 countries surveyed by the OECD, the average household income after taxes is $27,630.
- The average house in the United States has nearly 2.5 rooms per person (excluding bathrooms, utility rooms, garages, etc.) versus the OECD average of 1.7 rooms. Italy and South Korea have less than 1.5 rooms per person.
- Although US homes are larger than their foreign counterparts, Americans spend less of their annual incomes on housing, apprx. 17%, versus the OECD average of 20%.
- About one in eight Americans report they regularly work more than 50 hours per week at their job. In Europe, the ratio in most countries is less than one in 20.
- Accordingly, most working Americans spend less time on “leisure and personal care” – including sleep – than most Europeans. Here, the French are the champs. They spend about 16.5 hours a day on leisure and personal needs. Not surprising.
What does this tell us? Generally speaking, we are hard-working; we have bigger houses and spend less of our income on them; and we spend more time working and less time sleeping and doing leisure activities than our foreign counterparts. But here are some points from the report that don’t sound so good:
- Crime: On murder, the United States ranks high at about 5 murders per 100,000 population each year; among other OECD countries, only Mexico is higher at nearly 25 murders per 100,000 people; and most European countries are much lower at 1 or 2 per 100,000 people.
Yet only 2% of Americans report being assaulted over a year, among the lowest in the study and about half the OECD average of 4%. This contrast between murders and assaults is not easily explained.
- Welfare of children: About 20% of American children live in poverty, which – as defined by the OECD – is to grow up in households with less than half the median income of the total population. By contrast, the average OECD poverty rate for children in the 29 countries surveyed is 13.7%. That is a surprising finding.
- Obesity: More than one-third of US children aged 11 to 15 are overweight or obese, the highest rate among OECD countries and twice the average.
- After Mexico and Chile, the United States has the highest birth rate among teenage girls aged 15 to 19. That is very sad. Finally, reading proficiency among American 15year-olds is stuck at the OECD average.
Regarding the welfare of children, the OECD concludes that “the United States, Poland and Turkey rank among the bottom third performers.” That was a shocker to me.
So in some areas, the US remains at #1, but in others we are falling far short.
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Thanks for reading,
Gary D. Halbert