By Profit Confidential
I keep a keen eye on the second-biggest economy in the world simply because China is experiencing an economic slowdown that can and will affect the U.S. economy, and hurt the profitability of our U.S. multinational companies.
Since the beginning of this year, the economic slowdown in the Chinese economy has been gaining strength. In the second quarter, we saw the economic growth rate in the Chinese economy fall: the second-biggest hub in the global economy grew at 7.5% in the second quarter, compared to 7.7% growth in the first quarter.
When it comes to economic analysis, one thing I focus on is the long-term trend in statistics. When I do just that, the Chinese economy is going the wrong way—and I believe there’s trouble ahead for China.
We’ve seen this in the past with our own economy; when there’s too much credit and rapid expansion, an economic slowdown usually follows. Just look at what happened during the housing boom in the U.S. economy—credit grew, and we saw ruthless lending practices to attract subprime borrowers.
Right now, we are witnessing a significant amount of credit expansion in the Chinese economy. The total credit to the private sector has increased more than 166% between the first quarter of 2008 and the last quarter of 2012. (Source: International Bank of Settlement web site, last accessed September 10, 2013.) In the chart below you can clearly see how much credit has risen in the Chinese economy. This should be taken as a warning sign of just how deep the economic slowdown in the country must be.
My concern? What happens to the profitability of U.S.-based companies operating in the Chinese economy?
Let’s use General Motors Company (NYSE/GM) as one example. In 2012, the company sold 2.8 million vehicles in the Chinese economy. This brought in $33.36 billion for the company, a staggering 22% of its total sales. (Source: “2012 Annual Report,” General Motors Company web site, last accessed September 10, 2013.)
If we see the economic slowdown in the Chinese economy continue on its path, would companies like General Motors (GM) be able to keep the same levels of sales? And what would happen to GM’s stock price?
GM is just one example of a company embedded in the Chinese economy; there are many more, including Wal-Mart Stores, Inc. (NYSE/WMT), NIKE, Inc. (NYSE/NKE), Caterpillar Inc. (NYSE/CAT), and YUM! Brands, Inc. (NYSE/YUM), and other big American names.
I can’t stress this enough: the U.S. economy is highly connected to the Chinese economy. If the economic slowdown in China continues, then you can expect many large-cap companies in key stock indices to see their stock prices fall.
What He Said:
“If the U.S. housing market continues to fall apart, like I predict it will, the stock prices of major American banks that lend money to consumers to buy homes will come under pressure—these are the bank stocks I wouldn’t own.” Michael Lombardi in Profit Confidential, May 2, 2007. From May 2007 to November 2008 the Dow Jones U.S. Bank Index of the world’s largest bank stocks was down 65%.
Article by profitconfidential.com