Recent events in Turkey have reminded investors of the contagion risk coming to the U.S. stock market from abroad.
However, the biggest potential contagion is 14 times bigger than Turkey and deserves investors’ attention. Let us explore with the help of two charts.
Please note the following:
• Gross domestic product (GDP) of China is more than 14 times bigger than that of Turkey. Any potential contagion emanating from China will have a significant impact on the U. S. stock market because of the size of the Chinese economy.
• Please note from the chart that in dollar terms, the mainland Chinese market has dropped 31% from its peak.
• Please note from the chart that the Chinese currency, renminbi, is approaching the key level of 7 renminbi to 1 dollar. If that level is decisively broken, the U.S. stock market may come under pressure.
• While the Chinese stock market and currency have been falling, the Dow Jones Industrial Average DJIA, +0.43% the S&P 500 SPX, +0.33% — as represented by ETF SPY, +0.35% and Nasdaq ETF QQQ, +0.02% have ignored the developments in China. The reason is that investors in the U.S. are focused on popular stocks such as Apple AAPL, +2.00% Amazon AMZN, -0.23% and Facebook FB, -0.52% ; those stocks have been steadily rising, propping up the indexes. This is not likely to last if the Chinese stock market and currency keep dropping.
• The damage in the Mainland China ETF and iShares China Large-Cap ETF FXI, +1.32% is nowhere near the iShares MSCI Turkey ETF’s TUR, -0.51% China is a completely different situation from Turkey. In Turkey there is a significant current account deficit and there are large borrowings in dollars. In China there is a current account surplus and massive dollar reserves.
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What to do now
At The Arora Report we follow economic data from 23 countries. It is the situation in China that concerns us the most in terms of its impact on the U.S. stock market. The economic indicators in China are deteriorating fast. This does not mean that investors in the U. S. stock market should panic at this time. This is simply a call to be alert as the situation could worsen quickly.
The reason not to panic is that the Chinese economy is centrally controlled. The Chinese government has many levers that can be pulled to temporarily stop the deterioration.
We recently increased cash levels and hedges. We provide to The Arora Report subscribers precise levels of cash levels and hedges to hold as well as specific positions to buy, hold or sell. We are keeping a close eye on several important indicators related to China. In general, consider continuing to own good positions but hold higher-than-normal levels of cash and hedges. Also consider following a sophisticated model with a proven track record in both bull and bear markets. We follow the ZYX Global Multi Asset Allocation Model with inputs in 10 categories. Please click here to see these 10 important categories.
Disclosure: Subscribers to The Arora Report may have positions in the securities mentioned in this article. Nigam Arora is an investor, engineer and nuclear physicist by background who has founded two Inc. 500 fastest-growing companies. He is the founder of The Arora Report, which publishes four newsletters. Nigam can be reached at Nigam@TheAroraReport.com.
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