By David Sterman
Even as you keep an eye on our ever-rising stock market, it also pays to monitor global economic trends. And looking at the economic reports coming out of Europe and China, there is a growing cause for concern.
Slowing economic activity in these regions won't likely drag the U.S. economy into recession. But it could lead to slower-than-expected growth, creating a vast disconnect between stock valuations and corporate profit growth.
A quick pullback
Just two months ago, I noted
the International Monetary Fund (IMF) saw clear reasons for optimism, predicting that China's economy would grow more than 8% in 2013 and 2014. They even expected beleaguered Europe to finally get off the mat later this year and start to grow again.
Today, hopes of a European recovery are vanishing and China is looking a bit more tepid.
Why should you care? Because Europe accounts for 25% of global gross domestic product (GDP) and China represents another 13%.
Simply put, nearly 40% of the global economy is on the backs of Europe and China, so we count on these areas for export stability.
Back in January, I relayed comments from European Central Bank President Mario Draghi that Europe was starting to benefit from a "positive contagion." Indeed, economic feedback loops can prove to be quite virtuous, and Europe might finally be on the cusp of rising regional trade after a half-decade slump.
Trouble is, the Eurozone Purchasing Manager's Index (PMI) is now pointing to a negative feedback loop. This index rose to 48.2 in January, as noted here, inching ever-closer to the 50.0 mark, which would signal an economy that is no longer contracting.
Well, the PMI slipped to 47.9 in February and 46.5 in March. The falling PMI signals another quarter of recession in Europe, and recessionary economic activity leads firms to cut staff and further reduce capital-spending plans, which sets the stage for further economic weakness.
Whereas the IMF predicted in January that Europe would exit the recession this summer and generate slightly positive readings on a full-year basis, the European Central Bank just issued a report predicting a 0.5% economic contraction this year.
Despite the deepening economic morass, the Vanguard MSCI Europe ETF
), which is a proxy for Europe's largest companies, has been rallying since last June. Make no mistake, Europe will eventually prove to be a fertile region for investors when the major economies start growing, but it's looking less certain that we'll seen any upturn for the next year or two.
China's head fake?
The headlines out of China are clearly not quite so dire, as government officials predict another year of solid growth. To gauge the market's view of Chinese economic growth, we can look at commodity prices, as China's insatiable appetite for commodities means that global spot prices directly reflect Chinese economic activity.
Yet copper prices have stumbled in recent weeks...
...while aluminum spot prices have fallen from 96 cents a pound in mid-February to a recent 87 cents a pound. For that matter, lead, zinc and nickel prices are all off more than 5% in the past 30 days. The commodities market appears to imply that China's hoped-for 8% GDP growth is at risk.
As an article in Bloomberg notes, the possible slump in commodities demand may be tied to the fact that "China's industrial output had the weakest start to a year since 2009." Notably, China and Europe are key trading partners, and weakness in one region can spill over to the other.
Risks to Consider: Economic snapshots need to be viewed over a multi-month time frame, and the recent troubling signs out of Europe and China are only a month or two old.
Action to Take: If economic statistics relating to Europe and China continue to lag for another month or two, then look for economists to signal fresh concern about the global economy. Also, earnings season begins in a few weeks, providing us with a fresh read on global economic conditions. Many expect to see a fairly solid set of quarterly reports, yet it's the forward view that will determine the market's next move. In an ever-rising stock market, these are the kinds of issues you need to be monitoring.
David Sterman does not personally hold positions in any securities mentioned in this article.
More from StreetAuthority