How the State-Controlled Chinese Economy Affects Your U.S. Stock Market Investments

 

China devalued the yuan this month — an action which significantly affects worldwide companies that seek to sell their products in China. A currency devaluation means that it will now be more expensive for Chinese companies and citizens to purchase foreign goods.

Chinese currency devaluation is a protectionist strategy aimed at keeping Chinese spending within the country, thereby shoring up domestic industry. You might see articles insinuating that the devaluation of the yuan is a move toward a more free-market currency. But don’t be fooled. China has had as firm a grip on its currency, for decades, as it has had on overall Chinese life. “The Chinese government is interested only in creating absolute advantage for its enterprises and a high standard of living for its people,” says Kevin L. Kearns, president of the U.S. Business & Industry Council (USBIC).

 

“Why does Chinese industry need shoring up? I thought business was booming in China?”

Well, business WAS booming in China. But the country’s annual GDP growth has been dropping for five years now.  Morgan Stanley commented last week, “we believe that the magnitude of excess capacity in China remains large.” Therefore, investors can expect China’s GDP growth to continue its downward trend. Due to the economic contraction, Chinese companies and consumers will have less money available to spend than they did in recent years.

 

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“What else is happening that I need to be aware of?”

Most countries sell products in China. Therefore, there will be companies all over the world which will see lower-than-expected revenues in their immediate futures. These changes in revenue expectations lead directly to lower-than-expected earnings. Fluctuations in earnings dictate stock prices.

 

“Bottom line, what’s the bad news for stock investors?”

All sudden economic and geopolitical changes cause stock market volatility, and the devaluation of the yuan is no exception. Companies that sell products to China will have sudden downward revisions in earnings forecasts, leading to drops in their stock prices. The more revenue a company typically derives from commerce with China, the bigger the drop you can expect in its stock price.

In addition, companies that sell basic materials and energy commodities, which tend to boom during periods of economic expansion, will conversely suffer during periods of economic contraction, such as is taking place in China and emerging markets.

 

“How do I protect my stock market investments from the effects of Chinese currency devaluation and slowing GDP growth?”

It’s time to circle the wagons. Let’s talk about two types of U.S. stock investors: people who own mutual funds, and people who own individual stocks.

If you own mutual funds, you’ve probably noticed that your growth & income funds have been slow- or negative-performers this year, your large-cap growth funds have been slow performers, while your mid- and small-cap stock funds are growing moderately. None of the U.S. stock markets are having an attractive year, but at least the mid- & small-cap stocks are beating the returns from bonds and savings accounts.

There are two types of U.S. companies which are suffering from Chinese actions. Companies that sell products in China will sell less of them, due to the devaluation of the yuan making Chinese purchases of U.S. goods more expensive. Also, the Chinese economic slowdown leads directly to drops in energy & materials prices — oil & gas, chemicals, metals — due to lower product demand.

Thus, many large companies — which are heavily concentrated in the Dow Jones Industrial Average — are being adversely affected. Stock prices are suffering at Apple Inc. (AAPL), Caterpillar (CAT), Chevron (CVX), DuPont (DD), 3M Company (MMM), Procter & Gamble (PG), and United Technologies (UTX). That’s why your growth & income mutual funds haven’t grown this year.

Smaller U.S. companies tend to do less business with China, and therefore, their stock prices will likely maintain normal growth patterns, based on their earnings trends. The big caveat is that companies of any size that produce energy-related goods & services & materials will continue to suffer.

While it’s normal and healthy for stock markets to experience slow years, you can tweak your mutual fund portfolios to maximize potential growth. My suggestion is to move away from Dow-invested stock funds, toward S&P 500 and NASDAQ stock funds. If you want to make an extra effort, keep an eye toward avoiding mutual funds which are heavily invested in energy & materials companies.

If you invest in individual stocks, your job is actually easier than the mutual fund investors’ jobs. Avoid stocks with bearish charts. Really, it’s that simple! Because if a U.S. company were suffering from the Chinese situation, its share price would have already fallen!

I always stick with stocks that having growing earnings projections, low price/earnings ratios (PEs), moderate debt levels, and bullish charts. For example, the Goodfellow LLC Portfolio for Second Half 2015 is up 8.81% so far, compared to the S&P 500 which is up only 1.38% since July 1st, and the DJIA, which is down. And both of the other Goodfellow LLC model portfolios for 2015 are also beating the Dow and the S&P 500!

You can find such recommendations every week on the

Goodfellow LLC home page, in Monday’s Buy List.

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See my recent articles about U.S. and Chinese stock market trends.

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Eight of the ten 2012-2014 Goodfellow LLC model portfolios

outperformed the market averages by margins of 50-100% and more!

 

Send questions and comments to research@goodfellowllc.com.

Happy investing!

 

Crista Huff

President

Goodfellow LLC

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