Rally's future hinges on China

By Jim Jubak

If this rally is to keep going, it needs China.

In the last few days, the rally that began after the March 9 lows has started to look a little ragged around the edges. The huge move up in the banking sector after Wells Fargo's (WFC, news, msgs) pre-announcement that it made $3 billion in the first quarter has been punctuated by big down days like April 13, when the KBW Bank Index ($KBX) dropped 4%. Tentative optimism about retail sales and a possible bottom in the U.S. economy now alternates with pessimism about retail sales and the lack of a bottom in the U.S. economy.

Face it: We aren't getting enough unambiguously positive news out of the U.S. economy to keep investors from getting nervous once the Standard & Poor's 500 Index ($INX) had climbed by 25% from its March 9 low. Nervous investors sell on anything that sounds like bad news. These sellers aren't convinced the rally will run much longer, and they're looking for the door. They'd rather sell than give back the profits they made in this upturn.

A chance to prolong optimism

That's where China comes in. Starting in March, Chinese stocks have staged an impressive rally that has pushed the iShares FTSE/Xinhua China 25 Index (FXI, news, msgs) up 44% from March 2 through April 15.

The move has been strong enough to ignite rallies in copper and in the Australian dollar, because a recovering Chinese economy would mean an increase in purchases of raw materials such as copper, iron and coal that Australia ships to China.

And while the Chinese economy simply isn't big enough -- or consumer-oriented enough -- to pull the global economy out of recession, an economic recovery in China would mark a bottom for the global economy as a whole. A rally in China and China-related stocks and currencies would at least prolong the current rally in U.S. stocks as it gave U.S. investors reason to believe that the U.S. economy might be close to a bottom, too.

But now that rally is pressing up against resistance levels set by the January highs for Chinese stocks and the Australian dollar. For that rally to go further -- and to pick up investor spirits that have started to flag on ambiguous U.S. domestic economic news -- the Chinese economy is going to have to deliver a solid dose of good news. Will it?

The good, the bad and the uncertain

Here's my scorecard on the economic news out of China in the last few weeks.

Unambiguously positive:

• Crude oil imports hit a one-year high in March. Steel mills imported record quantities of iron ore in March. Chinese buyers have been snapping up copper on world markets. It looks like Chinese companies, having reduced inventories of raw materials as the global slowdown took hold, are now stocking up in anticipation of future demand.

• Car sales hit a monthly record in March. That's the third straight monthly increase. Housing sales have picked up in major cities.

• Business confidence has improved. Managers' confidence climbed in the first quarter, according to the survey conducted by the National Bureau of Statistics. Confidence as measured by this survey had collapsed at the end of 2008.

Unambiguously negative:

• Exports continued to plunge, falling 17% from March 2008. That follows a 26% year-over-year decline in February. China's trade surplus fell to $19 billion. That's about half of what it was in March 2008.

• Unemployment continued to climb among China's 140 million migrant workers. These workers from rural areas have felt the brunt of job cuts in China's export sector. An estimated 20 million of these workers are now out of work.

• More small to midsize Chinese exporters are having trouble paying their bills. The U.S. credit crunch had a Chinese equivalent. State-run banks continued to make loans to big state-run enterprises, but they cut off credit to many smaller exporters. Those companies, in desperation, turned to their suppliers for credit. And now, judging by what it costs to insure against a customer default in China, more and more of these companies are having a hard time paying back these loans.

• According to a survey by Coface, a big credit insurer, 90% of Chinese suppliers have extended credit to their customers. That's up from 70% a year ago. A quarter of those companies that had extended credit said that accounts overdue by more than six months made up more than 2% of sales. At that level, a default by a customer could push a supplier into crisis.

Unambiguously ambiguous:

• The Beijing government's call for banks to increase lending has been too successful. As of March, banks had extended loans of $674 billion, close to the government's target of $735 billion for the entire year. The government has, in response, threatened to tighten the supply of bank credit. Too much tightening would stop the economic recovery dead in its tracks.

• Because of all this lending, money supply, as measured by M2, grew by 25% in March. In the past, China's central bank has moved to restrict credit and to raise interest rates when the money supply grew at rates like this. Efforts to get money supply growth under control could also stop the economic recovery.

Where does that leave investors? Skeptical but optimistic, I'd say.

Continued: A vote of confidence in the global economy

 1 | 2 | 3 | next >