Could the Chinese Economy Pull Down Key North American Stock Indices?

I am watching the Chinese economy very closely, because any economic slowdown there could have an adverse effect on the already struggling U.S. economy.

And here’s what I’ve seen: the stock advisors are not mentioning how critical the Chinese economy really is, how companies based here in the U.S. can face hard times if it slows, and how that could ultimately lead to lower key stock indices.

Dear reader, the most important thing you need to know about the Chinese economy is that it’s an indicator of global economic health and demand. Currently, it looks as though its health is deteriorating. Exports from the Chinese economy to the global economy plunged 3.1% in June, a month in which they were expected to increase by four percent. (Source: Reuters, July 10, 2013.)

What that means is that demand in the global economy is declining—and that strengthens my belief that the global economy is headed toward an economic slowdown. In June, exports from the Chinese economy to the U.S. economy fell 5.4% and those to the eurozone fell 8.3%.

Customs spokesman in the Chinese economy, Zheng Yuesheng, said, “China faces relatively stern challenges in trade currently… Exports in the third quarter look grim.” (Source: “China warns of ‘grim’ trade outlook after weak exports surprise,” Reuters, July 10, 2013.)

The Chinese economy is now expected to slow to 7.5% this year. But not only exports are declining; the factory output and investment growth in China, the second-biggest economic hub, are also headed downhill.

I think these numbers might even be too optimistic considering the economic slowdown in the Chinese economy could become severe, as the credit market problems are starting to unfold. Businesses not being able to borrow money to run their daily operations can hurt demand in the country. Consequently, high unemployment will probably become an important issue going forward.

Economic slowdown in China means U.S.-based companies operating in the country will also see their profitability decline. We’ve heard from companies like Caterpillar Inc. (NYSE/CAT) that are showing concerns with their operations in the Chinese economy; meanwhile, other companies—like Wal-Mart Stores, Inc. (NYSE/WMT), which has significant operations in China—are facing troubled times as well.

And you can add to this list the exporters to China—any economic slowdown in China’s economy means they will be selling less to the country. As I said before, the strength of the Chinese economy is an indicator of overall global health.

As I continue to point out in these pages, the key stock indices are not reflecting the reality of the economic situation—it’s far worse than they would indicate.

I remain pessimistic toward the key stock indices, because I don’t see a lot of improvements; rather, I see risk piling up significantly. This irrational rally can only go on for so long. Eventually, it will all come back to where it should be. And problems in the Chinese economy might just be the spark that brings investors back to their senses.