A frequent financial headline surrounding the recent volatility in our stock market was the impact of China's economy on our own. While it should be no surprise that financial markets and economies around the globe are intertwined, China with its sheer size and impact is a special case.
Here are a few thoughts for financial advisors as they seek to explain China’s impact on our stock market to their clients.
Sheer Size
China is the world’s second largest economy behind the United States. Not only do they have trading and business relationships with the U.S. but operate on a global scale in many economies and countries.
China is also a major market for anyone selling goods, services and raw materials as it has the world's largest population and an extremely large consumer and industrial base. .
U.S. Companies Doing Business There
Many major U.S. companies are doing business with or in China. The list of major corporations includes Apple Inc. (AAPL), General Motors Co. (GM), Boeing Co. (BA), Caterpillar (CAT), Yum! Brands, Inc. (YUM) and many more. In fact, China is Apple's second largest market after the U.S. and Yum!'s KFC brand is very popular there. According to Goldman Sachs Group Inc. (GS) the company derives 52% of its overall revenue from China.
A recent decision by China to devalue its currency hit both Apple and Yum! Brands hard with one day drops in their stock price of about 5% each.
Auto makers like GM and Ford Motor Co. (F) will feel any slowdown in consumer spending and the impact of the currency devaluation in their sales. This could impact their worldwide sales, their profitability and ultimately their stock price. About 30% of GM’s sales come from China so any slowdown would have a major impact on their bottom line.
Caterpillar’s CEO had already forecast a sales decline in China earlier in the year. Their stock is down some 30% from its 52-week high as of publication. The company’s sales in China are down by double digits for the third straight year. (For more, see: Impact of the Chinese Economy on the U.S. Economy).
China’s rising middle class has helped many consumer products companies build sales there. Any pronounced slowdown will hurt profit and likely impact stock price. This and the devaluation of the Chinese currency makes imported goods more expensive for Chinese consumers. Some other examples of consumer products companies dependent upon China and the region for a high percentage of their sales include:
LVMH Moet Hennessy Louis Vuitton ADR (LVMUY) earns 25% of its revenue from China and other parts of Asia excluding Japan.
Burberry Group PLC (BURBY) earns 30% of its sales from the region.
Prada SpA ADR (PRDSY) earns 20% of its sales in the China region.
Global Impact
China’s growth has not only helped U.S. companies prosper but also many in Europe, elsewhere in Asia and Australia and elsewhere. The current slowdown has dampened China’s demand for raw materials and oil which has served to depress commodity prices worldwide. This has hurt companies and nations who depend on this business for a significant portion of their economy.
Though the U.S. is not as directly impacted as others around the world, some U.S companies have felt the pain, especially those in the energy sector. For example Exxon Mobil Corp. (XOM) has seen its stock price fall from its 52-week high of about $98 to about $72 as of the time of this writing. Likewise the stock of Chevron (CVX) fallen from its 52-week high of just under $126 to its current price of around $75.
For many countries China is the largest buyer of their goods and services. For example almost a quarter of Chile’s exports go to China. Exports account for about 10% of Chile’s economy about double that of the United Sates. While a slowdown in Chile may not directly impact our stock market if enough of the rest of the world feels the impact of a China slowdown the impact will eventually be felt by our economy and our stock market. (For more, see: China's Economic Indicators, Impact on Markets).
China's Reaction to Falling Stocks
China is still a state-run communist country that is struggling to open its stock market to the west and has the will and checkbook to intervene when it feels it's necessary. Case in point: The Communist Party's response to flagging stocks and growth — to spend some $235 billion to buy shares and bolster prices, as well as impose limits on the sale of stocks (such as a ban on shorting) — was a swift and powerful response worthy of political and social unrest, much less the market's natural response to prevailing conditions. (For related reading, see: How Advisors Can Help Clients Stomach Volatility.)
Therefore, the risks within China’s markets and their economy may carry parallel risk for U.S. and other western firms doing business there. China’s current economic slowdown, their less than open financial markets, and other factors are sending chills to investors in our stock markets and are a major contributing factor in the market volatility we’ve seen during the late summer of 2015.
Implications for U.S. Investors
In the past, a U.S. investor might take a flyer on a fund that invested in Chinese stocks. For example the description of Fidelity China Region (FHKAX) reads:
“The investment seeks long-term growth of capital. The fund normally invests at least 80% of assets in securities of Hong Kong, Taiwanese, and Chinese issuers and other investments that are tied economically to the China region.”
As discussed above the impact of China's economy upon the world’s stock markets, including ours, is vast and as we’ve seen over the past few weeks profound. More U.S. companies depend upon China for a significant amount of their sales. Also, many of the U.S. companies operating in China are large and may be significant components in indexes such as the S&P 500. The performance of their stock can impact mutual funds and ETFs held by U.S. investors. (For more, see: Is China's Economic Turmoil Good for the U.S.?)
The Bottom Line
In a global economy, the U.S. stock markets are susceptible to world economic events. China, as the world’s second largest economy, is a huge market for many large U.S. companies across a variety of industries. Any slowdown in China’s economy that has a significant and widespread impact on the revenue and profit of these companies will have an impact on our stock market.
