Why economic trouble in China may not spread to US

Investors, along with pretty much anyone watching the stock market, took some deep breaths Monday, as the US stocks followed Asian ones downward.

Concern about China’s struggling economy had weighed on financial markets for weeks, and now the mood seemed grimmer than ever: Trading opened with the Dow Jones Industrial Average down a stunning 1,000 points.
 
But trouble in China isn’t synonymous with a threat of global recession.
 
In fact, plenty of voices spoke up with a message of calm on Monday. Today’s situation contains genuine uncertainty about the pace of global economic growth. It’s not clear how bad China’s economic turmoil will get or how strong the impacts on the world economy will be. But to many forecasters, the visible risks today aren’t of the global-recession kind of magnitude.

In the end, Monday’s downdraft didn’t end up as severe as the opening moments suggested.
 
The Dow still posted a hefty 3.6 percent decline – down some 588 points for the day, to close at 15,871.35. Losses in the broader Standard & Poor’s 500 index came even closer to a 4 percent decline for the day. And Monday’s selloff came after the Dow lost 1,000 points over the previous five days.
 
Outside the US, declines in Europe, Japan, and Hong Kong were on the order of 5 percent. Behind it all was an 8.5 percent plunge on China’s benchmark stock index that prompted a “Black Monday” label in Shanghai news reports.
 
For shaken investors outside China, though, analysts say it can be helpful to keep Monday's swoon in perspective. They cite several factors, chief among which is a US domestic economy that is still demonstrating some forward momentum.

While stressing that "economists can't even agree on predictions of things that already happened," Austan Goolsbee, a former top White House economic adviser now at the University of Chicago, told NPR. "[T]here are several things that at least make me feel better now than I felt in the fall of 2008. The first is the root of this crisis is not events happening in the United States. No. 2, there's in the US way less borrowing involved in this. It's just [an] equity bubble. It's just things moving around with stock prices."

Forecasters expect the latest reading on economic growth, coming this week, will show US expansion at a pace a bit above 3 percent annualized. The volume of home sales ticked up positively in the latest monthly report – to the highest rate in eight years – and improvement in the job market has brought unemployment down to 5.3 percent of the labor force.

That doesn’t settle the question of what the fair price is for US stocks. But some analysts say US stocks aren’t in “bubble” territory. “In absolute terms, valuations look average,” writes David Kelly, chief global strategist at JPMorgan Funds. Relative to yields on alternative investments, “they look cheap.”

What happens in China may not stay in China, but the effects shouldn’t be exaggerated.

“The recent data from other major economies have generally been good and there is little to justify fears of a major global downturn,” forecasters at Capital Economics, a global research firm, wrote Monday. Their view, not an unusual one, is that China’s slowdown won’t become a “hard landing” for that nation.

In general, global economists say the cooling of China’s economy ripples outward to affect emerging-market nations more than developed ones.

Demand for commodities like oil now is looking softer, and the decline in China’s currency puts pressure on other export-oriented economies. For the US, this might have only small economic effects – perhaps modestly weaker export opportunities to emerging nations, offset by some positive benefits as Americans reap more gain than harm from sagging commodity prices.

While the size of Monday's slump gave even hardened traders pause, the fact is that sizable downward “corrections” in share prices are a feature, not a bug, in a healthy stock market, analysts say. If a stock market goes too long in one relentless direction with little volatility, it’s often a sign that investors have mentally checked out.

A “trend is your friend” attitude can lead to prices rising far beyond what fundamental facts justify. Then, analysts say, look out when such a bubble bursts. For example, America’s Nasdaq index today is still below the peak it reached more than 15 years ago in the era of hype about dotcom stocks.

By contrast, volatility shows some tug and pull in the markets as investors collectively argue about appropriate prices for investments. It can seem unsettling, but if it helps avoid market bubbles a useful purpose has been served.

It's been nearly four years since the US stock market has had a correction – a drop that's at least 10 percent (and less than the 20 percent that's known as a bear market). Typically, corrections happen more like once a year or so.

For long-term investors, dips can be buying opportunities. With the S&P index down more than 10 percent from levels seen in July, some investment strategists see this as a good buying opportunity, or perhaps getting close to it. Yes, there’s the risk of more down days ahead.

But for a young or middle-aged worker with a steady paycheck, the larger point may be the long-term track record of the stock market (as embodied in diversified mutual funds) delivering positive returns for investors.

For millions of Americans, a preliminary hurdle is simply saving enough money to invest at all – in stocks or anything else. According to one bankrate.com survey earlier this year, more than half of Americans have no money in stocks or stock mutual funds.

For those who are saving for retirement, though, another hurdle is a “twice-burned” aversion to stocks, including among Millennials who were vicarious witnesses to the dotcom bust and Great Recession.

Mr. Kelly at JPMorgan acknowledges scenarios where things could go from bad to worse, even in the US. For instance, a severe global sell-off by investors could ripple into the "real" economy by affecting consumer confidence. But he calls such scenarios merely possible, "not likely."