26 October 2016
China's economic slowdown has affected prices of energy and other commodities globally. Photo: Bloomberg
China's economic slowdown has affected prices of energy and other commodities globally. Photo: Bloomberg

What will be the top economic theme for 2016?

In the wake of China’s much lower economic trajectory, prices of commodities — from aluminum to zinc — have declined.

First to feel the impact have been neighboring countries such as Korea, Taiwan and Singapore, which have been infected with slower growth and fears of recession. Countries that export iron ore, copper and crude oil have also been affected, especially Peru, Russia, Australia, Chile and Brazil.

Even the United States, the world’s biggest economy, now in its seventh year of expansion, has experienced disruption, primarily in the energy sector. The business models for hydraulic fracturing of shale oil and gas — or fracking — and for other energy producers have been turned on their heads as output prices have tumbled while input costs have remained the same.

Meanwhile, spreads on high yield bonds, which are disproportionately issued by energy companies, have widened dramatically.

Second wave

Big multinational energy, materials and capital goods companies based in the US have seen revenues taper off for two reasons. One-third of this multinational slowdown can be attributed to a stronger US dollar, which makes exports more expensive, with the rest due to the widespread waning of growth caused by the slower path of the Chinese economy.

Along with this slowdown, the US manufacturing sector has also cooled, resulting in excess inventory overhangs. On top of that, more US data releases have fallen short of expectations. For example, in the employment report for September, wages, new jobs and hours worked were all disappointing, suggesting that the US economy is still expanding but at a slower pace.

Even measures of the service sector have moderated. But is this the stuff of recessions?

The National Bureau of Economic Research — the group that officially calls the beginning and end of each business cycle — lists the causes of recessions going back to the 1880s.

Reviewing that list, we can see a repeating pattern across 100 years of causal agents, ranging from sudden drops in government spending at the end of wars to commodity supply and price shocks, interest rate jumps, asset bubbles bursting and excess inventory accumulations. None of these recession triggers seem acutely present as we enter the fourth quarter of 2015.

In fact, US government spending has started to accelerate for the first time after declining for many years. Global commodity prices have been impacted — but pushed downward rather than upward. Central banks around the world show no signs of raising rates. And though there is a mild inventory buildup, the US is no longer the manufacturing economy it was in the 1950s. Today’s service economy is largely unfazed by swings in stocks of manufactured goods.

The road ahead

The least visible and direct effects of China and the associated global slowdown are the ones that interest me the most as an investor. These are the third-order influences on the income and spending of the US consumer, the biggest source of final demand in the world economy.

Historical experience suggests that energy prices affect the behavior of US consumers and thus — with a lag — global growth. Past episodes of energy price declines that were not set in motion by recessions have been followed about one year later by more consumption and faster world growth. We may already be seeing the signs: US miles driven annually are now rising after holding steady for years.

And the mix of new vehicle sales is tilting toward more expensive and less fuel-efficient automobiles and trucks.

In my estimation, we need to see some stabilization internationally before we can feel confident about committing new money to risk assets such as stocks and high-yield bonds.

But some of the implications of the bad news from China may end up being good news for the rest of us, by accelerating household and company spending and stimulating growth in those economies that use energy as a major input cost. Those economies are the US, Europe, Japan and — interestingly — even China.

So, while the final chapter of 2015 isn’t over, this expansion’s ruggedness — not its fragility — may be the most important story for investors looking ahead to 2016.

MFS Investment Management, a global asset management firm based in Boston, focuses on institutional investors in the Asia Pacific region.

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MFS Chief Investment Strategist

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