For those of you that know me personally, I am very tall – 6’5” in fact. As such, I was encouraged to play basketball, where my height would be a significant advantage, but I wasn’t a naturally good player. When I started, smaller, quicker players were able to fool me with pump-fakes and body lurches, pretending they were going to drive left towards the basket when they were really going to go right. Noticing this weakness, a junior-high basketball coach taught me how to avoid the fake signals. “Watch the chest, not the hands,” he said. It’s easy for an experienced player to throw their hands one way to mislead their opponents, but the momentum of their core is harder to fake.
It’s been a rough week for global equity markets, with the Dow Jones falling below another psychologically important 1000 marker: specifically, the Dow Jones fell to 15,985 last Friday. Since markets are generally forward looking – i.e. predictive of future behavior – you’d think that the economy was sending out distress signals. Is the market signaling core weakness or global recession? In the US at least, there aren’t any new, material stressors that would account for this fall. Market watchers know there are two basic reasons for the recent market correction: falling energy revenues and China’s slowdown. Now, the reduction in energy revenue is bad for top-line earnings in the energy sector. However, lower costs for energy is a net positive for the rest of the economy. At a recent PIMCO conference, I heard PM Scott Mather put it this way: “The reduction in energy prices is unambiguously good for the economy, but it is not uniformly good.”
Likewise, China’s projected slowdown in GDP growth rates, while material, is simply not a cause for panic. Yes, China’s rate of growth is the slowest it’s been in a full generation. However, that growth rate is still between 6% and 7% - healthy growth rates that would be the envy of the developed economies. The law of diminishing returns suggests that a slowdown will ultimately happen to any rapidly expanding emerging market and it is simply a case for prudent monitoring and re-evaluation.