China is increasingly central to the fate of emerging markets.
Take this emerging pattern: China’s economy slows and most commodities’ prices follow. Then many emerging market nations suffer.
The ones that specialize in shipping raw materials to China are affected the most. For years they have banked on feeding China’s gargantuan appetite for commodities. That, however, is living a risky existence.
The current slowdown and the one in 2015-16 were in part engineered by the Beijing regime, in a bid to curb the nation’s mountainous debt. But the truth is that China’s pell-mell gross domestic product growth has peaked, and now it will expand at a less-rapid clip, no matter what the government does.
China’s GDP growth rose in 2017, but this year, with constraints on once more, growth will be more muted. The ongoing trade war with the US also is weighing on China’s economy.
“It’s déjà vu all over again,” said Howie Schwab, portfolio manager for the Driehaus Emerging Markets Growth fund.
To be sure, many EMs are expected to have bright economic futures, regardless of China’s situation. Yet China will remain a factor in their trajectories, due to its size. And China’s 6.5% GDP growth rate expected for 2018 (per research firm Statista), down from 10.6% in 2010, still makes the country the envy of the developed world. And makes it the prime customer for EMs.
For the moment, China’s latest travails are reflected in commodity prices, which in turn push down EM stock markets. The exchange-traded fund (ETF) that tracks the Goldman Sachs Commodity Index (GSCI) is off 4% from its high in the spring. But because a chunk of the GSCI, and other commodity benchmarks, is in petroleum (now rising in price), that masks how much other commodities have plunged. Industrial metals, for instance, have taken a significant hit. Copper is down 20% this year. Nickel, iron ore, and others are sliding, as well.
China’s slowdown is not the only negative for commodities. The strong US dollar is a drag on them, too. Many commodities are priced in dollars, so when the US currency climbs, that tends to crimp commodity demand in other countries.
Upshot: The ETF that follows EMs (excluding China, which still technically is an emerging nation) is down 17.5% from its January high, amid sign of ebbing China shipments. This affects bourses ranging from South Korea (it has dipped 6.2% this year) to South Africa (negative 2.7%).
Concerned about China’s enormous debt—estimated at 328% of GDP—President Xi Jinping has been clamping down on borrowing and discouraging financial risks among businesses. Certainly, the ongoing tariff skirmishes are making his efforts to manage the economy much more difficult.
The hope is that the Beijing-orchestrated slowdown and the trade conflict can be reversed soon. Xi has indicated he will ease up on his efforts to curb credit, lest the impact of US tariffs begin to hurt China unacceptably. Beijing has cut taxes, lowered bank reserve requirements, and let the yuan drop to aid exports, noted Michael Arone, chief investment strategist at State Street. “They are slowing down on their deleveraging,” he said.
Alas, the trade war seems to have staying power. The US has imposed 25% duties on $34 billion in Chinese products, and Beijing has followed suit with tariffs on $60 billion worth of American imports. Pending in Washington is a Trump Administration bid to slap a 10% tariff on $200 billion in Chinese goods. Trade talks between the US and China have reached a stalemate. So Treasury Secretary Steven Mnuchin has indicated that any further negotiations with Beijing will be put aside until after Washington’s trade issues are resolved with Mexico, Canada, and Europe. That means prolonging the pain for China—and for EMs.
Washington can afford to take its time. The trade war thus far has hurt China and not the US. Strong corporate earnings and good economic data are in America’s favor here, wrote Diana Rudean, director of applied research at Axioma, a provider of risk management technology to asset managers, in a report. She pointed out that the US is pressing an advantage: The Chinese ship far more goods to the US, which means China presents a bigger tariff target. The Russell 1000 is up 5.3% this year, and China’s CSI 300 is down 12.7%.
So how much more will EMs suffer from collateral damage? On the plus side, most nowadays are better equipped to weather the storm. “They’re in a stronger position than five years ago,” said Ron Joelson, CIO of Northwestern Mutual, noting that, among other things, their foreign exchange reserves are a lot higher.
On the minus side, what remains to be seen is how much Xi will pivot back to big infrastructure construction, which calls for large amounts of EM raw materials. And while Xi has turned on the spigot for stimulus spending again, there is a lag time for when that produces better Chinese economic growth, estimated at around 12 months. And Chinese consumer demand drives goods and services throughout Asia.
The old saying is that when the US sneezes, the rest of the world catches a cold. When China, as the No. 2 economy, sneezes, it’s the EMs that get aches and chills.