Well, nobody said that rebalancing China's huge economy toward domestic consumption to rely less on exports for growth would be easy. The first day of trading of 2016 proves just this point -- but the markets' reaction to what happened in China is exaggerated.
What triggered the selloff that sent the Shanghai Composite index down by nearly 7% and the smaller, Shenzen Composite index, lower by more than 8% on Monday? Opinions vary, but one indicator that keeps cropping up in media and analyst reports is the unofficial manufacturing purchasing managers index, the Caixin PMI.
The index, released over the weekend, fell below market expectations to 48.2 in December from 48.6 in November. It was the 10th consecutive month of shrinking activity in the sector, and disappointed compared to expectations for a reading of 48.9 in a Bloomberg survey of analysts.
However, looking deeper into the figures reveals a picture that hardly justifies the global stock market plunge that followed. In fact, today's selloff is unlikely to be as bad as the August 2015 market panic that also started in China, as Jim Cramer points out.
The drop in the index was mainly due to a fall in the output component, which in turn seems to mostly reflect weaker external demand, Julian Evans-Pritchard, China economist at Capital Economics, said. He noted that the new exports orders sub-component fell sharply in December, to 47.8 from 51.6 in the previous month.
"In contrast, we suspect that domestic demand has held up reasonably well," he said. The official China manufacturing PMI, which was published last Friday when most global markets were closed for New Year's Day, improved slightly in December.
The official PMI is less sensitive to external conditions, and it came in at 49.7 in the last month of 2015 from November's 49.6, in line with expectations. Total new orders rose to 50.2 in December from November's 49.8, despite export orders continuing to shrink. "Meanwhile, service sector activity appears strong -- the official non-manufacturing PMI jumped to a 16-month high," Evans-Pritchard said.
A look at what type of companies make money also reinforces the idea that the Chinese economy is deep in the process of rebalancing towards domestic consumption. Industrial firms' profits fell in November by 1.4%. This was less than October's fall, which in itself is good news. Louis Kuijs, head of Asia economics at Oxford Economics, points out that profits in heavy industry sectors (generally more exposed to exports) plunged, but earnings in light industry sectors increased by between 6% and 14% year on year.
What does it all mean for the markets? First of all, investors should not panic. Today's plunge has more to do with the market "testing out" the shiny new circuit breakers (yeah, they work) and getting spooked by the approaching expiry of a ban on big investors selling stocks, than with the real state of the Chinese economy.
Secondly, investors should discriminate between the stocks that will suffer because of Chinese exports slowing down -- and here industrials like Caterpillar (CAT) and Joy Global (JOY) come to mind, as Chinese imports of their own products will slow -- and those that will benefit from the increased appetite of Chinese consumers, such as Action Alerts PLUS charity portfolio holding Starbucks (SBUX), or Nike (NKE).
And thirdly, remember Doug Kass's favorite saying: "The market has no memory from day to day." This selloff, too, could turn out to be a good buying opportunity for a few brave souls out there.
