By many measures, the U.S. economy is humming along. U.S. Gross Domestic Product (GDP) is tracking at about three percent for this quarter. Nerd alert: The four-week moving average of initial unemployment insurance claims is humming along at a level many economists would consider near perfect to facilitate growth. Labor productivity is on the rise as unit labor costs are on the decline. And after an extended battle, the United States is winning the fight against inflation.
However, the U.S. economy is enormous; its GDP is $28 trillion. An economy that size cannot exist without cracks and concerns. Corporations’ chief financial officers (CFOs) have unique perspectives on identifying these risks. According to the Richmond Federal Reserve’s CFO Survey, the Fed’s monetary policy (i.e., interest rates) remains the most pressing concern of businesses.
Concerns about interest rate policy are related to or caused by the fact that CFOs’ access to credit and funding is becoming more challenging. CFOs’ second biggest concern is maintaining their companies’ sales revenue in this economy.
Notably, CFOs’ concern regarding the overall “health of the economy” more than doubled quarter over quarter. That concern manifested in the CFOs’ downward shift in expectations for real (inflation-adjusted) GDP growth over the next four quarters.
Some CFOs shifted their expectations of GDP growth from 2.5 percent to 3.9 percent to 1.5 percent to 2.4 percent. There was also a notable jump in the expectation of a sizable recession (specifically, a contraction in the range of -3.0 percent to -1.6 percent).
A specific concern that has yet to be broadly discussed by CFOs—and much less by the mainstream media—is the worrying trend of bankruptcies. Personal and business bankruptcy filings rose 16.2 percent in the 12-month period ending June 30, 2024.
Perhaps CFOs have yet to remark on the growing number of bankruptcies because it feels more like a normalization than a warning. While bankruptcy filings have been increasing for the last two years, they have yet to surpass pre-pandemic levels.
My previous “Capital Ideas” column discussed economic stabilization versus a slowdown. The concept remains regarding bankruptcies: Normalization is fine so long as it stabilizes. However, bankruptcies have a rippling and magnifying effect, making stabilization challenging. The main concern for CFOs is the interest rate level, which is understandable. The pressure on their businesses and households during the tightening cycle contributed to the rise in bankruptcies.
The Federal Reserve cut interest rates by half a percentage point on September 18, 2024, and is expected to cut further. Theoretically, bankruptcies should be less of a risk now that interest rates are coming down. But an economist needs to ask, “From what vintage are interest rates coming down?” The Fed began raising interest rates in March 2022. If a household or business originated a variable rate loan a year ago, then perhaps they will receive some debt service relief. However, if they were fortunate enough to secure a fixed-rate loan before March 2022, and that loan rolls off, and new funding is required, the Fed’s interest rate cut may not be as helpful because the average interest rates for households and businesses have risen.
I am not so concerned yet about bankruptcies that I am reducing equity positions in my investment portfolios, but it would be reckless of me to expect a trend in place to conveniently stabilize.
China will do whatever it takes
On July 26, 2012, European Central Bank (ECB) President Mario Draghi gave the so-called “whatever it takes” speech. In that speech, Mr. Draghi used the word “crisis” five times, emphasizing the pain the Eurozone was enduring. But there was another message Mr. Draghi wanted to tell the world, and that was that the ECB was “ready to do whatever it takes to preserve the euro.”
In the United States, stock market investors know better than to “fight the Fed.” It turns out that when the ECB does whatever it takes to support their economy, investors can rely on that support. Draghi’s 2012 speech signaled investors to put cash to work in the eurozone, as well as in American companies.
Currently, China’s economy is handling its own form of economic crisis. In response, the People’s Bank of China (PBoC) Governor Pan Gongsheng had his own “whatever it takes” moment.
On September 24, 2024, China’s central bank announced its largest stimulus since the pandemic. In response, Chinese stocks had their best week since 2008 based on those stimulus expectations. I will spare you the details, but know that it was not just a massive amount—it was bordering on ludicrously massive. Not only did the PBoC announce a ton of financial support (cut interest rates, lending money to financial institutions to buy back stocks, reduced required capital reserves for banks), but additionally, the PBoC said they were willing to do more and more if needed.
Full disclosure: I took a small (three percent) position in Chinese equities in mid-November 2020 by investing in the iShares China Large-Cap ETF (symbol: FXI). I sold it about a month later. It went down a couple of percent while the S&P 500 went up a few percent, but that short-term return disparity was not a big deal to me, nor should it be to most investors. It was an opportunity to take some tax-loss selling to avoid taxes and swap into a hedged investment, replacing the riskier option (I considered it risky to invest in China at that time). But, more importantly, at that time, there just was not the support from the PBoC that would have kept me invested in FXI. This stimulus package is a game changer.
The PBoC’s stimulus announcement sparked the FXI ETF to jump 20 percent in one week. I hate to chase that performance, so I am still sorting out whether I will play this investment directly through Chinese equities or through non-sovereign beneficiaries. After the ECB’s “whatever it takes” moment, the U.S. stock market still performed better than the broader European indices. While there is an opportunity for massive outperformance in the relatively inexpensive Chinese stock market, not every opportunity needs to be acted upon. For the initiated with aggressive tendencies, I would suggest that your maximum exposure should be around a five percent allocation. If the PBoC’s policies work, you could get a better risk/return ratio in other areas. But, if I already owned any, I would hold my Chinese-based ETFs, and I would certainly not short the Chinese market.
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Allen Harris is an owner of Berkshire Money Management in Great Barrington and Dalton, managing more than $700 million of investments. Unless specifically identified as original research or data gathering, some or all of the data cited is attributable to third-party sources. Unless stated otherwise, any mention of specific securities or investments is for illustrative purposes only. Advisor’s clients may or may not hold the securities discussed in their portfolios. Advisor makes no representations that any of the securities discussed have been or will be profitable. Full disclosures here. Direct inquiries to Allen at AHarris@BerkshireMM.com.
