China, Oil and the Third World (01/19/2016)

The stock market has been pretty dismal since the last trading day of 2015. If you listen to the talking heads on TV and the rest of the media you’d think the U.S. economy is in bad shape, but how you interpret the news and other available information is important. The consensus of these groups is that: China’s economy is faltering (true), the price of oil has dropped dramatically (true), and the U.S. economy is about to crater, not true!

China’s woes are related to a slowdown in their economy caused to a great extent by a high level of debt and a lack of construction and manufacturing. China’s intent has been to become a more “supply side” economy going forward, emphasizing the consumer. This transition has proven more difficult than Chinese officials had thought. The changes in construction activity and manufacturing mean far less need for importing commodities. China’s high use of commodities, such as oil, in the past raised commodity prices worldwide to historic highs. Now with less need for commodities, prices are falling to low levels. Third world countries, like Brazil, Argentina and Russia, whose economies were based on the high prices of oil and other commodities to support their social commitments, are in economic and political trouble too.

The U.S. stock market is in a correction, which is a downward movement of about 10% from a recent high. A bear market is a downward movement of 20% from a recent high. Many factors can move equities downward: a tragedy, waning economy, or emotional negativity. Any one of these can have an impact that is very real at the time, but each differs in its longer-term impact. China and other third world countries, for instance, are undergoing a dramatic waning of their economies. This will be a longer term issue for them to correct. In many cases, they are now in bear market territory or actually in a bear market.

The U.S. stock market correction is one brought on by emotional negativity. This emotional negativity appears to be primarily a reaction to the declining Chinese and third world economies and a fear that this will happen in the U.S. In general, a market that goes through a correction, based solely on a tragedy or emotional negativity, bounces back up after a period of “healing.” The current case does not appear to be a waning of the economy for the U.S. Our export trade with China and other business activity are currently a small portion of our GDP. While growing slowly, the U.S. economy is growing. In the U.S. the price of oil is a benefit to the consumer, manufacturers and the transportation industries. Our consumers account for about 67% of the U.S. economy, and that brings a level of stability to our economy. The lower price of oil is bad news for U.S. oil companies, where about 190,000 jobs have been lost over the past year. To put this job loss in perspective, we must remember that the U.S. economy added 290,000 new jobs in December alone and the unemployment rate is at 5%.

The drop in the U.S. stock market is real but if you are a long-term investor, as we are, this correction will pass. Over the long term, we know that equities are a very important place to have your money, and diversification of that ownership is very important too.

Ed Mallon

January 19, 2016