Any time you invest in stocks, bonds or mutual funds, the value of those investments can increase or decrease. Volatility—the ups and downs of the stock market—is simply a part of long-term investing.
If you participate in your company’s retirement plan, you may have recently seen the effects of stock market volatility on the investments in your retirement account. You also may have heard that a recent drop in the stock market in China is causing headaches for global investors.
In our view, investor unrest is more attributed to declines in commodity prices than to the plunge in China’s stock prices.
First, a little history. In just 30 years, China has transformed from a very poor country into the world’s manufacturing powerhouse. In fact, China is second only to the United States in the size of its economy.
When China opened its borders to the outside world, its economy benefited from the relocation of manufacturers who took advantage of its nearly limitless supply of low-wage workers at the time.
China’s unprecedented growth, fueled by a stunningly fast pace of investment, generated an enormous demand for commodities. Commodity prices rose, creating a rush of investment by suppliers such as miners, drillers and farmers. China’s huge investment boom carried other economies along with it
China’s fantastic growth couldn’t last indefinitely. However, even as growth slowed, commodity suppliers continued to expand output and China’s industrial capacity continued to expand.
China is no longer as competitive as it was, in part due to:
We believe the real problem is that a lack of profits and years of excessive investment have led to immense over-capacity in China. The factors mentioned above have squeezed profits.
A drop in commodity prices sparked recent market turmoil and heightened investors’ fears. In a market economy, when prices and profits are declining, producers will adjust production levels. However, in centrally planned economies like China, providing jobs may be as important a motive for production as profits. So factories keep producing.
If China follows through on proposed reforms that would make it more of a market economy, it could gradually transition from an industrial economy to one driven by household spending. That could provide a stronger base for its long-term growth and spark improvement around the world. If that happens, it’s slump would likely be temporary and China would offer excellent prospects for foreign investment. If not, investors will be looking for a new source of economic energy.