Does anyone remember yesterday? Does anyone recall when oil went higher, miners rallied and the biotechs roared? Or that the industrials boomed because Warren Buffett bought one of their own, Precision Cast Parts (PCP)? Judging by today's market, no one remembers, as everything's being undone in one horrendous session for the bulls.
Last night I tried to be skeptical if not downright critical about the rally, suggesting that it could be easily repealed as the week went on. I didn't know it would be immediately repealed. But that's because I didn't think we would be dealing with a Chinese devaluation that makes their goods cheaper to export and our goods more expensive to sell there. Yep, that's exactly what happened, and I want to put in in a context so we know what could happen next.
First, China's desperate. Its communist government is trying to put everyone to work and at the same time end the corruption that has dominated many of its businesses. We keep hearing that it needs to grow the economy at 7% and it doesn't like the below-trend growth -- how much it is really below trend, we don't know. It tried exporting its way out but the principal market for its goods is in Europe, and that market fell into disarray with the European recession. Then it tried infrastructure, but it seems as if everything that needs to be built has been built and tales of see-through buildings abound. Then it tried the stock market, but it didn't put enough rules in place to protect the gamblers who borrowed huge amounts of money and sent stocks to ridiculous valuations before they cratered, wiping out the life savings of millions of Chinese.
This weekend we learned that Chinese exports dropped 8% -- an astounding amount for this export-driven country. So, the Communist Party resorted to a truly desperate measure: depreciating its own currency by about almost 2% -- an amount that might not seem like much for a country that has devalued before to stay competitive. But this move is five times bigger than anything the Chinese have done in the last decade.
It amounts to nothing short of a trade war, and that's why so many stocks, including stocks that were very strong yesterday, like Apple (AAPL) and General Motors (GM), are so weak today. Many of the industrials I talk about all the time -- like Eaton (ETN), Emerson (EMR) and United Technologies (UTX) -- could be hurt, too.
The change in the price of the Chinese currency may not in itself be enough to slow sales of any of those companies or their brethren, but the desperation of the move says that things are much worse in China than even the bears realize or they wouldn't be taking such extreme actions. That's how you could have Apple cascade 6 points and GM give up all the gains it made when it released strong U.S. numbers not that long ago.
The slowing of China has been an ongoing theme for ages. It's always followed by the caveat that even though it is slowing, other countries would kill for its growth, as the slowing is nothing more than a decline in the rate of advance, so to speak, meaning a 7% increase in growth going to a 5% rate. But what if this devaluation means that China has growth in the 2% or 3% range? Kind of like, well, the U.S.?
That means we have more risk to the world's growth than we thought. If the Chinese economy is in real trouble, as a sudden devaluation implies, then the raw commodities that China reliably buys are going to fall by the wayside.
That's already been the case for copper, iron and steel, all of which have been in a vortex of decline and pain ever since China's weaker growth. They have been in the house of pain for ages, and this action just shows that there is more pain, and perhaps bankruptcies and reorganization, ahead for many minerals and mining companies.
But we now definitely have to include oil in the mix. China imports amount to only 7% of the world's supply and most of that comes from Russia. However, if China is really downshifting, then some of the supply meant for China will have to go elsewhere. This surfeit comes at a terrible time for the oil producers, though, because the Saudis are continuing to pump like there's no tomorrow. That means the world price of oil has to go down even further. That's just what happened today, as oil finally took out the price it bounced off twice this year.
So now, when you think of it, we have a total repeal of much of what happened yesterday. The industrials, which were buoyed by Buffett's Precision Castparts buy, were hammered by the devaluation. The oils, which had been doing better because oil held the key $43 level and bounced, for the most part, gave up the gains when oil settled in at a six-year low. The techs, led by Apple, which had been thought to be doing better, gave up the ghost.
We need to keep in mind two things. The first is good, and the second is worrisome.
First the good: As I said yesterday, none of the companies with sinking stocks today has been in bull-market mode of late anyway. Yesterday was a fluke. The winners had been companies that were beneficiaries of the decline in commodities, or they do best when interest rates go lower. Rates plummeted today and the 10-year Treasury has gotten so low that you have to go back to being attracted to companies with 3% to 5% yields, as they are better buys than Treasuries. That means circling back to the consumer-packaged-goods stocks, like General Mills (GIS), PepsiCo (PEP) and Kimberly-Clark (KMB).
It also means that you can buy utilities like Entergy (ETR) and real estate investment trusts like one of my faves, Ventas (VTR). Domestic stocks with no Chinese exposure can go higher. Other companies, like Google (GOOGL), can still create wealth with a brilliant reorganization that shines a light on the real value of the company and dims the light on the parts of the company that are considered profligate.
But there's another, more worrisome side of the desperate move by the Chinese. They are not alone. Japan debased the yen in order to stimulate exports and get its economy going. Europe deliberately crushed the euro to try to win exports, too, something the Germans have pushed for aggressively and something that only got more pronounced the longer the Germans dragged out the Greek affair. Yes, they were huge beneficiaries of the inter-euro strife.
The one thing that all of these devaluations have in common is that the countries behind them expect to take sales away from U.S. companies, both within our country and outside of it. They want to depress our exports and boost their imports.
And it's working.
Which brings me to what has me so concerned. Our recovery seems real but it is shallow. Other than employment, there's nothing strong about the recovery at all. While it is true that rates have been kept down for a long time because of the Great Recession, it is entirely possible that any rate increase could cause serious repercussions for all of our international companies based here. How serious? It wouldn't shock me to see us thrown back into a recession if we aren't mindful of this worldwide trade war that's been declared against the U.S. I expect big bankruptcies in minerals and mining and, alas, oil. I expect layoffs in the industrial behemoths that are struggling to compete with the currency warriors as the dollar should soar against all of these other countries' currencies on that first rate hike.
In short, the Fed can do some real damage with a hike because of what's happening abroad. I don't want to start ranting that they know nothing, but perhaps it is time for Fed officials to recognize that if they are indeed data-dependent, then the data from the rest of the world is almost uniformly awful. Perhaps it's time they contemplate the potential systemic risk that comes from pummeling our economy from within.
That's what this commodity collapse seems to indicate. If we're not careful, we could reprise the 1937 recession within a Great Depression caused by a Fed that also felt it just had to raise rates because, well, the worst was over. It wasn't. We needed a war, a hot war, to end that recession after that hike. I don't know what could save us this time around. I just hope the Fed sees it that way because if they don't, things are going to get a heck of a lot worse before they get better and today's declines will become a staple of the rest of 2015.