China Pullback.

As I highlighted in the Stimulus Withdrawal section of my most recent client letter, when the governments of the world get serious about withdrawing monetary and fiscal stimulus, things could get ugly.

So far this year, the S&P 500 is down around 3% on a price-only basis. This may be a “healthy correction” in process, but it’s curious why the correction started just recently.

There has been a lot of speculation about why. The most popular explanation is, of course, political. President Obama and former Fed Chairman Paul Volcker are threatening to take a hatchet to the big bad bailout banks (tip of the hat to Donald Coxe).

Large bank stocks have sold off, and regional bank stocks have done well. So, there is some substance behind the political claim. But, bank stocks have not been the most significant component of the sell off. In fact, one can more reasonably look at commodities to see what may be going on.

Oil and copper prices are off around 12% since their peaks in early January. Natural gas prices are off around 14%. Could it be that the threat to large U.S. banks is causing a sell-off in commodities? Doubtful. Or, is it a reflection of a more fundamental pull-back in economic activity. And, if so, why?

Okay, enough teasing. China decided to rein in credit expansion by raising bank reserves and increasing borrowing costs. I think markets are reacting to this credit tightening because they understand that China, and other emerging markets with respect to China, are providing the marginal units of growth to the world economy.

Not surprisingly, the Shanghai Composite is off 8.4% since January 21st. Perhaps the U.S., Europe and Japan are no longer leading the world economy, and markets are reflecting what is happening in the far east.

What will happen now? I don’t know, and neither does anyone else. But, what China decides to do going forward with respect to government stimulus and credit creation is likely to drive markets for some time to come.

Unless you know someone with close ties to the highest levels of Chinese government, I don’t think anyone will be able to guess what will happen next, either.

This is no time to be overly bold or assume that timing the market is possible. It’s up to the whims of Chinese politicians in my opinion.

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.