What China's Stimulus Means for U.S. Markets

 | Sep 27, 2012 | 1:44 PM EDT
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We keep hearing that stocks have advanced and seeing the headline "Stocks Advance Because of the Hope for Chinese Stimulus."

This headline is a recurring excuse for any advance, particularly a commodity-led one, so perhaps it is worth parsing where we are with Chinese stimulus and what it means for our markets.

First, we always get excited about Chinese stimulus when we see the Chinese stock market rally like it did last night, with a better than 2.5% gain for the most closely followed Chinese stock index. That makes sense when you consider that the European stock indices all turned ahead of when the rich countries agreed, preliminarily at least, to help the poor ones.

But, that said, there have been so many false tells, or indications by that inherently unreliable if not fixed stock market, that we can't get too excited. Remember, that stock market remains in what seems like a tremendous bear market that has continually taken out lows and has fallen back to where China was before it actually did stimulate the economy successfully three years ago.

So, rather than get our hopes up, I think we should temper our expectations about when and how large the stimulus will ultimately be while at the same time slice our expectations about how bad things really are. In a world of slower growth, the idea that China could still grow at 5% to 6% would be outstanding, except for the fact that the consensus still believes in a 7%-9% trajectory.

That said, we often have too many stocks that go up on even a whiff of a stimulus program. So it is important to separate what should rally vs. what does rally.

First, when you speak of infrastructure, you are speaking of raw materials. China has a lot of materials already. It has tons of aluminum, even if it is a high-cost and dirty producer. That means stop taking Alcoa (AA) up. It doesn't compute.

We also tend to take up the steel stocks. Again, that makes no sense unless they can absorb all of the steel they dump worldwide. Unlikely. But that doesn't mean we shouldn't be buying the ingredients of steel that they don't have. That means iron. I like Vale (VALE) best, and that's what the charitable trust, Action Alerts PLUS, has been buying. Secondarily, they need nearby copper, and that's Freeport-McMoRan (FCX).

How about machinery? Although this is a second derivative, China will need engines and trucks and earthmovers. That means traders will take up Caterpillar (CAT) and Cummins (CMI) -- really these are the only two worth going with -- but those companies won't see a bump in time to save their quarters, and that is actually what matters.

Finally, there will be a step up in oil, and that's an area that I think is very investible, particularly because of our growing glut here. What China will need to do is import, and when it does, you will want to own not any of the major oils or independents but Schlumberger (SLB) and its oil-service cohort, such as National Oilwell Varco (NOV) and deep-water driller Ensco (ESV).

Now, to be fair, everything will go up on real stimulus news. I just want you to realize what you can own, which is just the above, and what needs to be sold as a trade, which is, alas, everything else.

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