Financial shell game: Blame it on the other guy

Have you ever known someone who was so busy finding fault with others he never bothered to see what his own problems were?

Judging by the start to the 2016 stock markets, it looks like the U.S. financial market talking heads and reporters are all playing that part.

China’s stock market lost 7 percent on the first trading day of 2016, and officials shut it down to make sure the bottom didn’t fall out.

Then the contagion spread across the globe, finally ending up hammering U.S. stock markets.

All the headlines shrieked that China’s manufacturing numbers and Middle East turmoil were to blame. Everywhere you looked photo captions and articles had some form of, “The grim start to 2016 was caused by weak Chinese manufacturing data and tensions in the Middle East.”

They’re looking past the real culprit.

First, Chinese economic data isn’t falling off a cliff. At least, that’s what most indicators would have us believe.

A story in Barron’s dated Jan. 5 but posted online on the morning of Jan. 4 likely caused much of the stir in the U.S. market — at least in the power offices on Wall Street.

It claimed the Chinese numbers are highly inflated and that most the Chinese economy is growing at about 4 percent, almost half its stated 7 percent gross domestic product.

When Barron’s publishes such a controversial piece, all the Street players have to react, simply to show that they read the piece and are duly impressed.

The problem is it’s an opinion. The view of the author, who is a senior economist at BNP Paribas Investment Partners (Asia) Ltd., is basically that the Chinese are transitioning from a developing manufacturing based economy to a more developed, diversified economy. And in that transition growth is getting hurt.

But even the article concludes it’s not a death knell for China — or any of its trading partners, for that matter.

The problem is when these stories are released, they tend to rattle the chattering class and institutional players on the Street, whether they’re valid or not. They don’t really care where the markets are because they make money when there’s turmoil, not when markets are going up.

As for the Middle East turmoil argument, please. There has been turmoil in the Middle East ever since oil was discovered there. That certainly isn’t roiling markets.

The real issue under these flimsy excuses for the global market sell-off is the U.S. economy is looking bad, as is Europe.

China’s manufacturing sector is off because the U.S. and Europe are not contracting to build things because people and companies are not buying as much of those things. There’s little supply when there’s little demand.

We aren’t hearing this narrative because the financial anchors and politicians are talking about how well the U.S. is doing.

The most egregious example of this was when the Fed raised interest rates last month. There was very little in the U.S. economy that supported an interest rate hike. But it’s an election year, and it’s downright American to be optimistic.

Inflation has been muted by low energy prices. Spending for the holidays was up, but not by much. Wages are low and not expanding much.

And then there’s the industrial and transportation side of the economy. No one really talks about these two massively important sectors.

The U.S. Purchasing Managers Index (PMI), which indicates whether businesses plan on buying more goods to make more things, is down again for December. Orders hit their lowest mark since September 2009. And the equally important Institute for Supply Management (ISM) report also shows another drop in manufacturing.

Both reports indicate a slight, but continued, contraction (not expansion) of the U.S. industrial sector. If companies aren’t building more products, it’s because there’s no demand. And if U.S. manufacturing is getting hit, it’s no surprise China is feeling it.

Add to this the fact that the Dow Jones Transportation Index, a basket of the nation’s top land, sea, rail and air carriers, is off 20 percent in 2015 (and continuing that slide into 2016).

The scary thing here is most of the cost of transports is wrapped around fuel costs. With prices at decades lows, these companies still are losing ground.

So the U.S. manufacturing sector is in contraction; the transportation sector looks terrible; the industrial sector is in a full-fledged recession; and the energy sector is being choked out of existence by Middle Eastern oil ministers.

Oh, and the U.S. dollar is a stratospheric levels making exports that much more difficult.

And exactly how is China is the problem?

This is no time to be a hero and try to bottom fish bargains. Stay away from the markets for now. January is going to be highly volatile as all the big players now reposition for the coming year. And no one knows what to make of the coming year.

Keep your eye on the U.S. economy and don’t be led astray by the talking heads or optimistic factoids. Replacing highly skilled workers with more low-skilled workers isn’t economic growth; it’s a shell game.

Real estate, hard assets and the U.S. dollar are good places to be right now.

–GS Early

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