China: The Trigger to Collapse Key American Stock Indices?

By Michael Lombardi, MBA for Profit Confidential

 
Why do only a few in the media and no politicians I can find seem to care about the warning bells being issued by the Chinese economy?
First, early this year, we heard the Chinese economy is going to grow at an embarrassingly slow pace in 2013 compared to its historical average. Forget a 10% economic growth rate and think seven percent or lower!
Now, we hear about more troubles…
Think the Detroit bankruptcy was bad news?
Local governments in the Chinese economy have piled up a huge sum of debt, and the central government is warning cities to manage their escalating debt.
China’s National Audit Office (NAO) announced this week it will be conducting a nationwide audit to assess the situation on local government debt. The reason for this? In 2010, the NAO found local governments in the Chinese economy owed 10.7 trillion yuan. Fast-forward to June of this year, and it turns out the number is about 12 trillion yuan. (Source: Xinhunet, July 28, 2013.)
Why does it matter to North American investors?
The Chinese economy is the second largest in the world; the U.S. is the largest. Economic issues in China will surely send “waves” towards us.
 
Dear reader, after the financial crisis, the developed countries in the global economy never really showed robust growth. This caused companies in the key stock indices to focus on emerging markets—they showed demand, and the Chinese economy was one of their main destinations.
As the economic slowdown deepens in China, and with possible credit issues in the country, it’s very likely that American companies in key stock indices that are operating in China will see their corporate earnings negatively affected.
I consider problems in the Chinese economy a major risk to the rising North American key stock indices.
Michael’s Personal Notes:
As talk of the Federal Reserve pulling back on its quantitative easing program continues, the housing market is starting to show signs of stress, confirming my belief that the so-called housing market recovery was held up by the easy U.S. monetary policy.
The announcement several weeks back from the Federal Reserve that it may taper its $85.0-billion-a-month money printing project caused mortgage rates to jump—and the higher rates are starting to affect home buyers. The Pending Home Sales Index, which measures contracts to purchase homes by home buyers, declined 0.4% in June. (Source: National Association of Realtors, July 29, 2013.) If we had a true housing recovery, that number would be in the double digits.
But there is more…
The Mortgage Bankers Association (MBA) expects Freddie Mac mortgage rates to average 4.4% in the third quarter of this year and 4.7% in the fourth quarter. (Source: Mortgage Bankers Association, July 25, 2013.) This essentially means the housing market will become less affordable for those who are looking to enter it.
And the prices of homebuilder stocks have been collapsing since mid-May. Below is the chart of the Dow Jones U.S. Home Construction Index. Just look at the dive in the index since mid-May and how far down it is for the year. This suggests the housing market isn’t as strong as it seems.

 Chart courtesy of www.StockCharts.com

The reality of the matter is that the typical home buyer who actually buys a house to live in is under scrutiny. The pages of Profit Confidential have been filled with the troubles these home buyers face…and recent third-party surveys are reaching the same conclusion.
In fact, a survey by the Associated Press found four out of five Americans are struggling with poverty and unemployment, and have had some form of reliance on welfare. (Source: Associated Press, July 28, 2013.) That means 80% of Americans are financially struggling.
Until the average American Joe starts to see his pocket grow, the housing market can’t go much further. There is only so much buying of empty houses that financial institutions can undertake. Millions of Americans live today in homes with negative equity.
I remain skeptical about the so-called housing market recovery. I won’t be surprised to see a further downtick in the number of home buyers entering the housing market as interest rates rise and the Federal Reserve moves towards normalizing the monetary policy.
Where the Market Stands; Where It’s Headed:
As the month of July comes to a close, both the Dow Jones Industrial Average and the S&P 500 are sitting at the same level they did in the third week of May. Hence, stock prices have gone nowhere over the past 11 to 12 weeks.
On a fundamental basis, stocks are overvalued.
The Dow Jones trades at 16.4-times earnings. Corporate profit growth is no longer what it used to be. The double-digit growth in quarterly profits that we saw almost every quarter starting in 2009 ended in the third quarter of 2012. We have now witnessed three quarters in a row where earnings growth has collapsed and revenue growth is marginal.
A phenomenon few are talking about: for the first time in years, the yield on a 10-year U.S. Treasury (2.6% as of this morning) is higher than the dividend yield on the Dow Jones Industrial Average (currently 2.3%). Why buy stocks when you can buy government-guaranteed T-bills that pay you more?
World economic growth is slowing. The chances of a “surprise” U.S. recession are high. All the money printing in the world cannot force consumers to spend more unless that newly printed money makes its way directly into the pockets of consumers—which isn’t happening.
I continue to believe that the stock market rally we’ve experienced since 2009 is a direct result of the biggest money printing program in U.S. history. But unlike others, I don’t think the Fed can pull back on its $85.0-billion-a-month printing program that easily. In the end, it will be rapid inflation, created by all this money printing, that pushes the value of the U.S. dollar down, pushes interest rates higher, and pushes the stock market much lower.