A Big Bowl of Chinese Porridge

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It has been apparent for years that the state of the Chinese economy has a major impact on global markets. If the headline number on Chinese growth is stronger than expected that is generally viewed as good for us here in the States. If growth is slowing in China then that is going to have a negative ripple effect on the global economy. So we want to see growth in China that is not too hot, but just right. This goldilocks growth scenario is tricky.

Are there drawbacks to things heating up in China? We are the major destination point for Chinese exports. The recent rise in commodity prices has acted as a closet “tightening” in the markets. Central banks have not ratcheted up rates but higher commodity prices have acted as a speed bump for all of us.

How can we gauge the impact of growth trends in China on our economy? We perhaps need to take one step back and look at things in Australia. The main export destination for Australian goods is China. The Chinese buy a large amount of commodities from the Aussie’s. With Chinese demand for commodities growing rapidly the price they pay for commodities has spiked recently. That increased cost for inputs is something we need to track here. That increased cost for inputs in China has to be passed along somewhere. Since we are the main export destination for Chinese exports we are vulnerable to higher prices charged for these goods. If inflation in China heats up too much it hits the American consumer in the wallet. Add these increased costs to greater payroll taxes and higher prices at the pump and we could have a cause for concern regarding the spending habits of the U.S. consumer. I will keep a close eye on rising inflation in China in the coming weeks.

The technical condition of the market remains strong but slightly weaker after volatile trading last week. There was a positive divergence last week as some, but not all, of the major averages broke below support. That positive divergence lead to a rally to close the week. That rally was not a robust one as some, but not all, of the major averages broke out above resistance, a negative divergence. The advance-decline lines I follow all hit all-time highs last week. The Dow A-D line broke out to a new high but the Dow did not. This is another near term negative divergence.

After the sharp advance to start the year the technical picture has weakened slightly. There is still far more right than wrong with the market. However, recent action leads me to believe that trading will become more volatile. Support for the S&P 500/Dow/NASDAQ/Russell 2000 is as follows: 1495/13,830/3117/897. If these levels hold the market environment will improve. If all of these support levels give way you could likely see our first extended sell off of 2013.

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About Thomas J Smith CFA