China has been the economic miracle of the world for decades. From Nixon’s visit in 1972 to its entry into the World Trade Organization to the current day, China has not had a negative growth year since 1978 and has average a 10% GDP growth rate. At the same time North American and Europe are ecstatic with an occasional 5% growth rate and typically languish in the 2% to 3% range. But, things are not all well in the Land of Managed Capitalism (by the Communist Party). Debt is rising and there is a potential for a long term trade war with the USA. Meanwhile, small and medium-sized businesses are laying off workers in China. For many of us, China seems to be a long way away. So, how do job cutbacks in China relate to your investments?
Small and Medium-sized Business Downsizing in China
The South China Morning Post is beginning a series about the China economy.
Chinese President Xi Jinping warned on January 21 that the Communist Party needed to pay particular attention to the risks to social stability from rising economic problems, as evidence increasingly suggests that the nation’s employment situation is deteriorating rapidly, particularly among small and medium-sized businesses.
An important aspect of this situation in China is that the prospect of a significant economic downturn is not just that there could be a recession or even an “economic hard landing” but that it could lead to significant social unrest. The article goes on to give examples of companies that have reduced their labor forces by more than 75%! The end result is survival, not repayment of debts or prosperity.
Chinese economic statistics have always been suspect, so anecdotal evidence is often relied upon to get an accurate picture of what is going on. What is known is that China has taken over a lion’s share of production in many industries from the rest of the world. Seventy percent of world electronic production capacity now is in China and the risk of a permanent trade war is taken very seriously, especially considering the amount of debt that companies and whole industries have taken on. As noted in the South China Morning Post article, many smaller Chinese businesses got into the habit of simply borrowing, expanding, and having enough money to service their debts. Now the world is changing and companies are downsizing very rapidly.
How Do Job Cutbacks in China Relate to Your Investments?
The first point of concern would be investments that you might have in Chinese companies. Investing.com lists 403 Chinese companies with ADRs available in the USA. If you are invested in any of these, you need to do your fundamental analysis and make sure if you want retain the investments in your portfolio or not. If you do not believe that you can do an accurate job at this because of sparse data, it might be better to sell.
The next issue is any other investment you might have offshore from the USA. We recently wrote about how offshore investment in Brazil was starting to look promising with the new government. But, Brazil and other exporters of raw materials will all have the same problem if China experiences a significant economic slowdown and quits importing at its current rate. The resource curse of boom and bust cycles is inherent in commodity exporters. There are relatively secure value investments offshore but you need to do your homework to find them and to assess their intrinsic value.
Direct Foreign Investment as a Guide
To know where to put your money offshore, a useful resource is the World Bank’s Foreign Direct Investment page of statistics. The most recent figures show that worldwide foreign direct investment was $2 Trillion in 2017, down from $2.5 Trillion in 2016. China received $168,223.58 million ($168 Billion) in 2017 versus $354,828.00 ($355 Billion) for the USA.
Meanwhile the European Union as a whole received $604,920.21! And Brazil came in at $70,685.05. It would appear that as the world economic situation worsens that money is flowing into developed economies more so than developing economies. Since this is where the smart money is going, smart investors will probably follow suit.
The World Bank updates these figures every year so it is always a useful resource for those wanting to invest offshore.
How Investments in the USA Will Be Affected
An old friend of ours recalled when the stock market crashed in 1929 and all of the businessmen in his small Midwestern town were not worried. New York was a long ways away and what happened there would never affect the prices of corn, soybeans, beef, pork, or eggs. Three years later our friend was burning corn cobs in his stove to keep the office warm because corn was cheaper than coal. The US Congress has picked a trade war with the Smoot Hawley Act and the US economy entered the Great Depression.
If you think that what happens in the country that consumes more natural resources than anyone else does not matter in the rest of the world you are dead wrong. Companies like Boeing, 3M, Procter & Gamble, Deere, Caterpillar, Apple, and many many others derive a substantial portion of their incomes from trade with the rest of the world and with China in particular. When a company in China lays off 700 of its 1,000 workers, those workers have no jobs or take lower-paying temp jobs. The effects ripple through the economy and more companies lay off more workers and the downward cycle continues. The growing Chinese economy has been a consumer of many Western products. We in the West would like to have more access their economy and that is a lot of what the looming trade war is all about. The risk is that China will not open up to the West but will look inward instead. Apple already downgraded its projections for China for the coming year. This is how job cutbacks in China relate to your investments if you have multinationals in your stock portfolio. Trouble in China will spread to many developing nations and sales of goods by the USA will suffer.
The one bright spot for the USA and other developed economies is that foreign direct investment and cash via the Forex market will seek safe havens in these economies.
What Can You Do?
Some time back we wrote about how to invest without losing any money. As economic risks increase a wise investor will rotate part of his or her holding into AAA bonds (Microsoft and Johnson & Johnson, US Treasuries, and even CDs at the local bank. Any stock investments should be value investments until the economic situation in China and elsewhere improves. If the economy and market worsen, there will likely be quite a number of deep value investments for those willing to do their homework.