Will China Derail the Bull Market?

Once again, investors woke to some bad news from China. After a disappointment last week in terms of exports and other worrisome data points, GDP numbers for the most recent quarter failed to meet expectations. That has caused only a small blip in U.S. stocks so far in premarket trading. Still, is relative weakness in the Chinese economy something U.S. investors should be worried about? Can problems there derail what is turning out to be a strong and resilient bull market in stocks? To answer those questions, you have to look beyond the numbers.

There is no doubt at this point that we are in a bull market. The S&P 500 closed on Friday 29% above the intraday low hit back in October, 17% higher than it closed out last year, with the Nasdaq doing even better than that. That, though, has been all about America. Investors have been encouraged by signs of an economic miracle here, with inflation, as measured by headline CPI, falling from above 9% a year ago to just over 3%. At the same time, unemployment has remained close to all-time lows. That shouldn’t happen. A rapid series of rate hikes should, in theory, have done some economic damage, but whether you give the credit to the Fed, the resilience and innovation of U.S. businesses, the Biden White House, Congress, or the Tooth Fairy, it has not this time around.

Just as remarkably, all that has occurred despite weakness in most of the rest of the world. Europe and the UK were in a rate hike cycle of their own to counter inflation, which has seen more traditional results in terms of a slowdown. Meanwhile in Asia, even Japan, which has been struggling with disinflation as long as most of us can remember, were raising interest rates. The outlier in the last year has been China, where a relaxation of their “zero Covid” policies have allowed that very important economy to bounce back strongly enough to offset weakness elsewhere.

We really shouldn’t be surprised that their strength is waning. What China is currently going through is basically what the U.S. went through last year, when stocks fell sharply for the first three quarters. The initial boom that followed the lifting of tight restrictions is ending, and after a strong period of growth, a return to more normal conditions feels like a big letdown. It is just that China is doing that a year or two after most others. They kept pandemic-related restrictions in place longer and are a bit behind the curve as a result.

However, we should never forget that there is one major difference between China and other powerful economies. In China, everything is centralized. Disregarding the politics and human rights issues, from a purely economic perspective, that has both good and bad implications. Most westerners are all too aware of the bad: We have always been taught that government control of an economic entity is inherently inefficient.

Governments are slow and clumsy, with decisions made for social reasons getting in the way of the kind of growth that comes with the pursuit of profit. The collapse of communism throughout most of the world has proved that point, but the Chinese Communist Party has survived and retained power because they saw that and adjusted, creating a state-run economic system that recognized the pursuit of profit. What they can do in that framework is to ensure that when conditions demand a pivot of some kind, it is done in an orderly way. So, when the economic data from China becomes worrying enough, the government should be able to turn the tap back on.

The downside, though, is that even in the Chinese profit-oriented, hybrid economic system, the one thing that overrides any economic consideration is the Party’s need to retain power, and that leads to some economic decisions that can be harmful. The big internet companies in China, for example, were allowed to grow until their economic power began to morph into social and even political power. Once that happened, they all faced restrictions that strangled their growth, and that created a slowdown that is still being felt.

For now, then, yes, weakness in China will cause some wobbles. It simply has to, given the importance of that country in not just the global supply chain, but also as a rapidly growing consumer nation. But what traders and investors have come to understand is that problems in China, in part because of the centralization that makes those problems more likely, are usually short-lived. The economic policy cycle is much shorter when changes come as the result of commands rather than suggestions and gentle encouragement.

That is why the reaction in U.S. markets to weaker than expected data out of China has been so muted to this point. Of course, that rests on the assumption that the Chinese government will do what it takes to boost their economy before long. History suggests they will, but should they decide that restricting the power of the new generation of successful entrepreneurs is more important than economic well-being, the view of traders and investors here will change rapidly. It is the political climate and power dynamics in China, not the economic conditions, that we should be watching closely, because decisions made with that in mind are what could ultimately derail the bull market.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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