Tuesday, May 9, 2017

China Has Now Become The Biggest Fear For Markets

By Patti Domm
CNBC
May 9, 2017

Stocks are at record highs, the VIX is at a 10-year low, and while investors are relieved the French presidency did not go to an anti-euro candidate, new risks are filling the void.

Topping the list of market worries is China, which has been on the back burner for months now. Some weaker-than-expected data, however, has put spotlight on the country's economy.

Last week, PMI manufacturing data showed signs of slowing, and China's trade data overnight was weaker than expected, with misses both on imports and exports. Chinese inflation data was due Tuesday.

"I'm more concerned about the risks stemming from a China slowdown," said Jeff Kleintop, Charles Schwab chief global investment strategist.

Commodities have sold off on concerns. Copper was down about 3 percent last week amid concerns about China, and off another 1.4 percent Monday.

"Some of this might be some warning signs that China could be the next thing that would throw the market a curve ball," he said. If the Chinese economy loses so much steam that its currency weakens a lot, and commodities continue to sell off, it could be a negative for other markets

"The government has slowed down on infrastructure spending, thinking private sector spending would pick up and offset it. I'm just worried rising interest rates, tighter conditions and some new down payment requirements could nip that in the bud," Kleintop said.

China President Xi Jinping is expected to consolidate his power later this year at the party congress in November. "Now that the political hatches are battened down, the main risks in the world today are still deflation, not inflation. A significant slowdown in China could be deflationary," said Paul Christopher, chief international investment strategist at Wells Fargo Investment Institute.

Christopher added, however, that China has responded to signs of weakness and market sell offs, as in August 2015, by easing credit and stepping back from reform, when necessary.

"For a long time, China was a high impact, low probability. Now the near term risk of a slowdown has a higher probability but probably a lower impact," he said. "Slowdown does not mean financial disruption."

He said the rest of the world is stronger and would hold up much better now than a year or two ago. "The Chinese have shown if they get into reform and the economy slows, they are able to moderate the speed of reform in order to maintain stability. They are not so gung ho on reform that they want to risk the stability of the markets," Christopher said.

China's Shanghai index was lower Monday, while other Asian markets were higher. There were reports that officials are looking to curb some of the speculation there, and there has been talk of reform in the financial markets from cross market risk.

Some of the other risks around China have eased however. President Donald Trump has said he would not call China a currency manipulator.

"I think Xi has been very cautious in reacting to anything Trump has said," said Kleintop. "I think China's won any meeting they had with Trump or Trump officials. So far they've been coming out on top."

"The unknown, unknowns are still out there. The VIX is quite low. The market is near a record high, and could we get a blip that causes a pull back? If it doesn't affect the economic recovery, our advice is still to buy," said Christopher.

Christopher said China's economy is a bigger worry if the U.S. does not follow the reflation policies laid out by President Trump when he won the election. Markets have become skeptical of how quickly tax reform can be enacted, especially since the Senate plans to come up with its own health care bill.

U.S. stocks held their ground Monday, and did not react much at all to the French election. The S&P 500 eked out a 0.09 point gain, closing at a record 2,399.38. The VIX, which is the CBOE, Volatility Index, fell 7.6 percent to a 10-year low of 9.77.

China is also clearly a key in potentially resolving tensions over North Korea's nuclear program. Investors were watching for any activity from North Korea ahead of South Korea's presidential election Tuesday. The front-runner there, Moon Jae-In has signaled a more conciliatory tone toward North Korea, and a less friendly stance on the United States.

"Geopolitical risk is one of those black swans where you can't predict the timing. You just watch. In the case of North Korea, what we're watching more carefully is whether there is another nuclear test," said Christopher. "That seems to be the red line President Trump has drawn and it's not clear what arrangements he's made with the Chinese...I really think they would have worked something out, in the event there's another nuclear test."

He said it's unclear if either China or the U.S. would act without alerting the other.


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