Why Investors Shouldn’t Let China, Oil Rule Their Decisions

— -- Economic distress in China and the declining price of oil have become the twin boogeymen blamed for the stock market’s precipitous fall this year.

January ended with the S&P 500 down 5.6 percent for the new year and the Dow Jones Industrial average off 6 percent. It was the worst start to a year since the Great Depression.

Yet, when you look behind the scary headlines, it becomes clear that China is like the computer-generated bear in the movie “The Revenant” – a fearsome illusion. And this illusory bear is a big factor pushing stock prices to the point where some pundits have forecast the onset of a bear market, thus ending the bull market that has run since 2009. Yet there’s a strong case to be made that investors are overreacting to perceptions that deviate widely from reality.

The perception is that China is experiencing economic woes, which will have a negative impact on the U.S. economy. But China’s economy is anything but woeful despite its wobbly stock market.

Economic growth in China has certainly slowed. But China’s gross domestic product (GDP) hit a new record in 2015 – about $10.8 trillion. China’s growth rate has declined from double-digits to an estimated 6.9 percent, but that’s still substantial growth that Americans, with our current growth rate of 2 percent, would be giddy over. To say that China’s not growing fast now is like saying that someone who has slowed from 120 to 90 miles per hour isn’t driving fast.

Sure, China’s slower growth is having an impact on many nations’ economies because their exports to China are slowing. But while the U.S. imports a lot of stuff from China, we don’t export much to them. These exports total only about $100 billion annually — about sixth-tenths of one percent of the U.S. economy. So an actual economic slowdown in China wouldn’t spell doom for the U.S.

One reason for China’s slower (not slow) growth is that it’s becoming a more mature economy after going great guns for the past 15 or 20 years. The country is moving from concentrating on exports to supplying its own consumers with goods and services, and this has led to overcapacity.

In that context, slower growth is only natural. Lower industrial output in China means its oil consumption rate isn’t escalating as fast as it had been previously. So fears about China’s growth are linked with stock market fears about the effects of rock-bottom oil prices on the markets.

We keep hearing about the diminishing demand for oil, and how its price has plummeted from more than $100 a barrel in 2008 to $30 in late January. Global demand for oil isn’t rising as fast as it had been and global oil production continues to rise. But since last year, global demand for oil has actually increased from 92 million barrels per day to about 96 million. (China and the U.S. are using more oil every year.)

In the oil market, there’s a thin line between glut and shortage. When oil cost $100 a barrel, there were 400 million barrels in U.S. commercial storage. Today, this figure is about 480 million, which is only an extra four days of supply. This current “glut” represents an above-ground supply so small relative to usage that it can become a shortage quickly. This is one reason why prices are so volatile. One minor supply disruption can rapidly suck out the excess in storage, and we no longer have a glut. Commodities experts know this, but many stock investors apparently don’t. They’re projecting long-term impacts from a situation that could reverse very quickly.