China is slowing because the world economy is slowing

Sometimes I read what others think and just smack my head in amazement–why didn’t I think of that!

I had that feeling this last week in reading about a brief interview with Wells Fargo’s former CEO, Dick Kovacevich. Mr. Kovacevich said Tuesday that China’s economy has slowed because the rest of the world has decelerated.

This view is in contrast to what many are saying and thinking: that the world economy is slowing because China is slowing. When you think about it, Mr. Kovacevich’s interpretation makes more sense.

China’s economy has mostly been serving as the world’s workshop. Goods are manufactured there and sent to the rest of the world. The inputs that China uses to build all those products come from both inside and outside of China, but mostly outside (iron ore, coal, oil, copper, etc.).

If world growth slowed, that would cause China to slow down production in reaction, which would lead to a lower demand for inputs, which would cause commodity prices to tank–just what we’ve been seeing over the last year.

China isn’t driving demand or creating growth, it is reacting to growth outside China. Of course!

So, why then is the world economy slowing? The quick answer is bad policy. If you look at the Middle East or Russia over the last several years, you see gross government overreach leading to military incursion, loss of lives, destruction of property, misallocation of capital, etc. If you look, too, at places like Brazil, where a massive oil and gas find turned into massive government corruption, you see more bad policy (government ownership/control of oil/gas fields) leading to economic troubles. Then, if you look at Japan, Europe and the U.S., you see central banks trying to create economic growth by fiddling with interest rates and money supply. As Dr. Phil would as, “How’s that working for you?”

The world economy has slowed in reaction to bad policy, and that has turned, first, into significant declines in input prices (commodities), and then, second, into slowing and economic upheaval in China.

A reversal will require either a change from bad policy to good policy (through elections or changed policies due to the threat of elections/being ousted), or for the power free markets to overcome the dead weight of bad policy. Either solution will take time, though, so it wouldn’t surprise me to see markets continue their recent instability.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

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China is slowing because the world economy is slowing

Does everyone believe the market will continue to climb from here?

Not John Hussman. Hussman makes his case in his latest Weekly Market Comment.

Although Hussman gets very close to attempting market timing, which I don’t believe anyone can do successfully, he does make some very good points about why the market’s returns from here may not be very exciting.

Luckily, we don’t need to invest in the market per se, and it’s possible to get significantly better returns in the right investments.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Credit spreads too thin?

John Mauldin’s latest Thoughts from the Frontline Weekly Newsletter featured an excellent article by Michael Lewitt of Harch Capital Management.

The subject was the state of credit markets. This may seem like an unimportant subject to many observers, but it impacts the financial markets and global economy in ways most don’t grasp.

Specifically, the article talked about how credit spread are still very thin compared to historical average. What are credit spreads? Generally, they are the difference between the yield on a risky credit (corporate debt, mortgage backed securities) compared to a non-risky credit, which is considered to be a government bill, note or bond depending on the maturity of the bond.

When the credit spread is wide, market participants are worried about credit risk and are demanding a large spread over risk-free securities. When the spread is thin, the market is unworried about credit risk and is demanding very little compensation over risk-free securities.

Historically, credit markets go through swings of greater and lesser toleration for credit risk. Typically, the market gets complacent after a long period of low defaults and then gets over-concerned after a short period of high defaults.

Right now, we have just recently come off some of the lowest credit spreads in history. The normal result is a market shake-up that returns low credit spreads to high credit spreads. These can be very disturbing events, as it was in 1998 when Long Term Capital Management collapsed.

Credit markets tend to reflect the market’s toleration for bearing risk. When the market is complacent, it signals trouble may be ahead. When the market is worried, it frequently signals a great time to invest. In my opinion, we are on our way from complacent to worried, and that means opportunity lies ahead.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.