Can China Turn Inward? Searching for Alpha, September 2009

When China sneezes, the world catches a cold. Especially in the energy markets.

Word that Chinese imports may be significantly muted by the economic turndown sent shock waves through the oil patch. While crude prices have dropped about 5% over the last few trading sessions, Chinese share prices are down by double that amount.

Perhaps the Middle Kingdom is looking at the situation in the wrong way. With more English-speaking folks in China than there are in the U.S., what could potentially be the largest middle class in the world is right in their backyard. Thanks to government reforms that began only ten years ago, this demographic owns an apartment or house, takes vacations, and is familiar with leading foreign brands.

If the growth of this emerging middle class continues, it could become a significant consumer. This would serve to reduce the current account deficit of the U.S., propelling our domestic economy out of the malaise in which it is currently entrenched.

This so-called "de-linking" theory--in which emerging market economies are able to a create consumer class that can augment the declining purchasing power of the U.S., is the foundation of the bull market case. For this scenario to play out, the economic stimulus offered by China must continue, even in the face of the 9.8% economic growth forecasted for that country in 2009. Indeed, Chinese PMI rose about 6% last month, indicating a further expansion in output. But without further policy accommodation, even this level of growth won't be enough to get the global economic engine humming again.

The Monthly Index Report for August 2009

Index

Aug-09

QTD

YTD

Description
S&P 500 Index*

3.4%

11.1%

13.0%

Large-cap stocks
DJIA*

3.5%

12.4%

8.2%

Large-cap stocks
Nasdaq Comp.*

1.5%

9.4%

27.4%

Large-cap tech stocks
Russell 1000 Growth

2.1%

9.3%

21.9%

Large-cap growth stocks
Russell 1000 Value

5.2%

13.8%

10.6%

Large-cap value stocks
Russell 2000 Growth

1.0%

8.8%

21.2%

Small-cap growth stocks
Russell 2000 Value

4.7%

16.8%

10.8%

Small-cap value stocks
EAFE

5.5%

15.1%

24.8%

Europe, Australasia & Far East Index
Lehman Aggregate

1.0%

2.7%

4.6%

U.S. Government Bonds
Lehman High Yield

1.9%

8.1%

41.0%

High Yield Corporate Bonds
Calyon Financial Barclay Index**

0.7%

-0.5%

-4.2%

Managed Futures
3-mo. Treasury Bill***

0.0%

0.0%

0.2%

All returns are estimates as of August 31, 2009. *Return numbers do not include dividends.

** Returns are estimates as of August 28, 2009.

Ben Warwick is CIO of Memphis-based Sovereign Wealth Management. He can be reached at ben@searchingforalpha.com.

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