Lost in the hand-wringing about the latest U.S. jobs report was some economic news that could have equally large implications for the stock market: worse-than-expected inflation in China. The latest report showed inflation jumping 3.6% year-over-year in March, above the consensus expectation for a rise of 3.3%.
Why is this data point, which hasn’t been given much play in the financial media, potentially important? Primarily because it restricts the extent to which China can cut interest rates to head off a “hard landing.”
With Operation Twist coming to an end, and the world’s major developed-market central banks all having wrapped up quantitative easing operations fairly recently, the onus is now on monetary authorities in emerging markets to provide the next round of stimulus.
And if China can’t lead the way with aggressive interest cuts, as expected, the implications for global growth could prove significant.
This latest tidbit of inflation data might not be isolated. Consider this quote from Monday’s article from MarketWatch:
“Looking ahead, however, (Bank of America Merrill Lynch analyst Ting) Lu said there’s little chance inflation will ease much in coming months as gasoline prices remain elevated, and as the government plans further increases in utility charges, such as water and electrical power. He also cited increasing labor costs as a factor that would help stoke inflation.”
What It Means for Traders
Click to Enlarge This latest piece of news is another potential red flag for any industry or company that is dependent on exports to China. Take the Brazilian iron ore producer Vale (NYSE:VALE), which ships 45% of its production to China. According to Businessweek, the company has idled two ships and postponed delivery of another two vessels because of falling demand from China. Even though the stock trades for only six times forward estimates, it has nonetheless fallen more than 14% from its Feb. 3 high.
Click to Enlarge Similarly, consider the Australian iron ore and metals producer BHP Billiton (NYSE:BHP). Like Vale, BHP is heavily dependent on China, with 30% of its exports going to the country. And, like Vale, the stock is down more than 13% from its February high even though it’s trading for 12 times forward earnings and sporting a 3.1% yield.
Click to Enlarge All of this comes at a time in which the economically sensitive areas of the U.S market are showing pronounced weakness. On Monday morning, the Energy Select Sector SPDR (NYSE:XLE) moved below its 200-day moving average, while the Materials Select Sector SPDR (NYSE:XLB) needs to fall only another 2.6% before it violates its 200-day. If XLB follows XLE below its 200, consider it a major warning sign for the rest of the market.
For now, the best bet is to exercise the highest level of caution with respect to stocks that depend on China for revenues. Last week, Jim Woods wrote that a number of individual companies could suffer as a result of falling exports to China. At some point, however, it becomes more than a company-specific story: Last year, the United States exported more than $100 billion to China, making it our third-largest trading partner. If China indeed enters a period of stagflation that defies a monetary solution, Vale and BHP won’t be the only stocks to take a hit.
Traders would therefore be well-served to watch China’s economic data as closely as they watch our own.
As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.