WASHINGTON – Will US stocks recover? Or are they headed even lower? The optimists tell us that Wall Street panicked in the last few days. Forget about China. The fundamentals of the US economy are solid. There is no reason to liquidate stocks. Therefore:“Be smart. Buy the dip!”
Over valued stocks
This is almost unbelievable. We all know that US stocks are over valued because of an unprecedented stretch of zero interest rates decreed years ago, at the time of the financial crisis, by the US Federal Reserve. As traditional savings accounts became non viable, most people went into stocks, therefore inflating valuations. We know that. Besides, we also know that many major companies, instead of investing in additional capacity, have been busy buying their own stocks. Obviously this provided extra support. However, it is clear that IBM and others cannot inflate their share price for ever by propping up their stocks in this way.
Modest GDP growth
More broadly, there is an obvious disconnect between modest US GDP growth (about 2% a year) and stellar stocks valuations. And this modest growth is not going to improve. The Congressional Budget Office (CBO) just revised down its own optimistic projections for 2015. According to the CBO, the US economy will not grow at 2.9%. Most likely the rate is going to be only 2%. Well, that is 30% less than estimated only a few months ago. So, no improvements.
All this should be enough to tell us that a major stock market correction was indeed in order. In fact, whatever the daily gyrations, probably we are not quite done with that.
China: worse than you think
That said, if we look at the global economy, there is reason to be even more pessimistic. First of all, the China story. Well, it looks that it is much worse than it appears. For starters, for the first time major business media are openly saying what many have been suspecting all along. The Chinese authorities falsify their growth statistics. China says that it is growing at 7% a year. Well, make that 5%, or even less, according to many analysts. This is no mere detail. This tells us that China’s problems are most likely bigger and deeper.
And since most of China’s growth comes from fixed investments, especially in construction, a major slow down of this gigantic engine has and will have an enormous negative ripple effect across the global economy.
Consider this. In the 1990s China steel production was about 100 million tons a year. Today it is 1.1 billion tons! However, because of the slow down, this capacity represents double its current demand. That’s more than 500 million tons over capacity!
And what is the effect of this rise and fall of production on world iron ore prices? Iron ore used to be $ 30 a ton in 2008. Thanks to China’s demand, it went up to $ 200 a ton. Now it is down to $ 100.
This means that major producers made huge investments to increase their capacity, counting on continuing Chinese demand. Well, now they are in big trouble. BHP Billiton, a world mining giant, just announced its worst results in 12 years. Profits are down 86% .
End of the BRICS
So, thanks to China, commodity prices are down, way down, hurting many producers across the globe. To make matters worse, commodities happen to be abundant in poorly managed emerging countries. So, falling economic fortunes have to be added to garden variety mismanagement, incompetence, corruption, and political crises.
Mix this nasty brew and you see that all the famed BRICS are out of luck, (India is probably the only partial exception). China aside, Brazil is in very poor shape, while there are mass protest against President Dilma Rousseff. Under performing South Africa just announced a GDP contraction. Russia has been hit by the double blow of low oil prices, and economic sanctions due to the Ukraine crisis.
Dismal prospects almost everywhere
You want more? Abenomics failed in Japan. The economy is anemic at best, and there is no plan to diminish the burden of a monumental public debt. Saudi Arabia will run huge deficits because of lost revenue due to low oil prices. Turkey is in political turmoil, while its economy is sputtering.
Almost the entire Arab World is in chaos, with civil war in Libya, ISIL in Iraq, and self-destruction in Syria. Europe is barely treading water. Its southern periphery is and will continue to be in bad shape. France is doing poorly. Coming into the Western Hemisphere, Canada is also suffering because of low oil prices.
US to be affected by the global economy
Given this rather uninspiring world scenario, the idea that the US will continue to do well because of our “good fundamentals” is just crazy. First of all, our fundamentals are rather weak. Secondly, we live and operate in a global economy.
Because of its insane investments binge, China used to drive growth. Now it is dragging a good portion of the world economy down. And there are no other locomotives of comparable size.
The idea that America can keep chugging along all by itself, even if at a modest rate, while the rest of the world is losing speed or worse is a complete fantasy.