foxex: The China Syndrome

The Market Sum | Investopedia

Insight after the bell

By Caleb Silver, Editor in Chief

Monday's Headlines

1. Markets Slip on Earnings Weakness Blamed on China

Markets Close

Dow
24,528.22 -0.84%

S&P
2,643.85 -0.78%

Nasdaq
7,085.68 -1.11%

VIX
18.94 +8.73%

INV Anxiety Index
101.15 Neutral

US 10-Yr Yield
2.744 -0.33%

Markets Today

Stocks fell hard today, but bounced off session lows as the DJIA gave up 1%, while the S&P 500 and Nasdaq shed 1.2% and 0.8% respectively. Disappointing earnings results from Caterpillar (CAT) and Nvidia (NVDA) led the decline. Both companies failed to beat analysts estimates and provided weak outlooks for 2019, blaming a slowdown in China as the cause. Blaming China is a major trend among multi-national companies and it is not going anywhere. We have heard to same refrain from Apple (AAPL) and Intel (INTC), and now Caterpillar and Nvidia. There will be more.

Shares of CAT fell more than 9% while shares of NVDA fell more than 14%.

The Shutdown Quantified

Government dysfunction in the U.S. cost the country $11 billion in lost GDP, according to the Congressional Budget Office. That's about 0.3% of GDP which, while relatively small, may prevent the U.S. from hitting 3% GDP growth for 2019. That would be the first time the U.S. misses the 3% mark in 13 years. The partial shutdown was lifted last Friday for three weeks as President Trump and Congress seek a broader agreement. Of the $11 billion lost, the CBO estimates $8 billion may be recouped over the coming quarters, provided that another shutdown does not occur.

Fund Flows Back into Stocks

After a December of intense selling, retail investors (you and me!) are back to buying stocks again. According to investment research firm TrimTabs, which tracks fund flows, inflows into U.S. equity mutual funds reached an estimated $7.6 billion as of Jan 19th. That's the most on record since February 2016. It's a good sign that investor anxiety has tapered a bit. Retail investors continue to stay away from ETFs, according to TrimTabs. More than $14.3 billion has flowed out of ETFs so far in January - the most since last February.

Why it Matters

Most retail investors own mutual funds through their retirement accounts like IRAs, 401ks and Roth IRAs. While ETFs have grown in scale and popularity, they are still a fraction of the market compared to mutual funds which are a better barometer for investor appetite. While stocks have recovered handsomely so far this year, the $7.6 billion worth of inflows is still paltry compared to the outflows of December. If you look at the chart below, you'll see that outflows from mutual funds were happening all year. Net inflows in the first three weeks of the year is either a sign of renewed investor confidence, or a seasonal boost in contributions as people restart their 401k and IRA contributions. Either way, we are coming back into stocks, and mutual funds are benefiting.

Who Really Owns the Market, Anyway?

We write a lot about institutional investors and their sway on the market. These are the mega-banks, endowment funds, foundations and hedge funds that can deploy billions of dollars towards their asset classes of choice. Given their size and influence, they are often the first in and first out of an asset or asset class like stocks. When they move, retail investors (you and me) typically follow with a herd-like mentality. That said, it is retail investors who own most of the stock market - at least in the U.S. The corporate equity market in the U.S. is $48 trillion, as of 2015 (the last accurate measure.) Households and mutual funds own about 65% of that, according to Goldman Sachs. Pensions, government retirement funds and foreign investors own most of the rest. But it is Mom, Pop, and you and me who own the lion's share.

Among retail investors, it's the wealthiest classes who mostly own stocks. That shouldn't come as too much of a surprise since wealthier people theoretically have more to save and invest than everyone else. What is surprising is how households in the 50-90% range of the wealthiest in America have nearly halved their holdings of stocks between 1989-2016, as you can see in this chart from Goldman Sachs.

Why it Matters

Retail investors basically owned the market in the 1940s-1950s through pension plans and stock brokers representing individual clients. The rise of the mega-bank through deregulation, globalization and the creation of exotic securities changed all that as Wall Street, Canary Wharf and Sheung Wan (Hong Kong) became global finance sectors. Professional investors came to dominate the market and new products like mutual funds and ETFs were offered to retail investors who ceded control to professional money managers. Those who could afford those products and the price of the fees associated with them benefited from that relationship in good times. In bad times, like the recession of the 1970s and the Financial Crisis of 2008-09, retail investors were shaken out of the market. Many never returned.

Given the lack of real wage growth for the working class and the concentration of wealth in a small percentage of households, most people have missed out on the benefits of stock ownership, the compound annual growth it can deliver and the income it can provide for real life needs like a college education, buying a home or retirement.

It's unfortunate that the privilege of investing is limited to so few people who can afford it. That said, investing is more accessible to people at any income level than it has ever been given the decline in fees, the advent of online investing platforms and apps.

The S&P 500 has returned about 6% a year (adjusted for inflation) for the last 50 years. It may not always do that, but it's a tough track record to bet against.

Stay smart and stay invested.

Today's Headlines

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Chart of the Day: Stocks with a China Problem

As speculation over U.S.-China trade negotiations drags on and China shows clear signs of a slowdown in economic growth, companies that rely significantly on revenue from the world's second largest economy have been feeling the pain. The latest victims to succumb to China problems have been Nvidia and Caterpillar, both of which announced on Monday that declining China demand is substantially impacting revenues. But China-related revenue concerns are not new. In early January, Apple CEO Tim Cook sent a letter to investors lowering the company's revenue forecast on weak China demand. This prompted a large, one-day gap down for AAPL stock. The chart above shows the downward trajectories and one-year performance figures for all three stocks.

Well ahead of Nvidia's mid-February earnings release, the high-profile semiconductor company lowered its fourth-quarter revenue guidance on Monday due to "deteriorating" global economic conditions, especially in China. NVDA stock plunged by more than 18% at one point on Monday before paring some of its losses. For its part, construction equipment maker Caterpillar specifically cited "lower demand in China" in its Monday earnings release as a key reason for disappointing overall sales.

What seems to have become a disturbing trend for U.S. companies doing significant business in China may have just gotten even worse. The White House announced on Monday that its trade advisor and known trade hawk Peter Navarro will be a key U.S. negotiator in trade talks with a Chinese delegation this week. Navarro is a notorious hardliner on trade issues, particularly when it comes to China. In December, Navarro rocked the markets when he said "China is basically trying to steal the future of Japan, the U.S., and Europe." While Navarro's presence at the negotiating table is likely problematic, though, even more pressing for U.S. companies is China's ongoing economic slowdown.