Dollars and Sense: Stock drop in China ripples around the world

Selling off. The Dow Jones Industrial Average is in negative territory for the year after last week’s sell-off, which is continuing today. We’re in the midst of earnings season on Wall Street, and the numbers have been OK. But revenue, forward-looking statements, and a slowing global economy are causing the sell-off. The Chinese stock market dropped 8 percent today, despite strong measures put in place by the Chinese government to prevent large shareholders from selling.

Commodities down. The slowdown in China has also contributed to weakness in the commodities market. Over the past few months, we’ve seen drops in commodities such as gold, copper, and oil. China consumes as much as 40 percent of some commodities, mostly in manufacturing and construction processes, so a slowdown there has a big impact. The U.S. economy is growing, but because it’s more oriented toward services, growth here will not make up for a slowdown there—at least as far as commodities are concerned. Gold prices are at their lowest in more than five years. For many U.S. consumers, this is not bad news. The prices of lots of things—from gasoline to foreign travel—are going down. But countries that are net exporters of commodities, including Russia and Brazil, are feeling pain. Both countries are officially in recession.

Earnings season OK. Of the companies that have reported so far this earnings season, 70 percent have come in above analyst expectations. That’s significantly better than the 63 percent that typically beat expectations in a quarter. But only 51 percent have beaten on revenue, below the 61 percent historical average. U.S. companies were expected to post their worst sales decline in nearly six years in the second quarter, in part due to the strong dollar reducing the value of U.S. companies’ overseas income. Thomson Reuters estimates profits will fall 2.9 percent. Also putting downward pressure on stock prices is the price-to-earnings ratio, which appears (finally) to be reverting to the mean. The S&P 500 is currently trading at nearly 17 times forward 12 months earnings, about 15 percent above its historical average.

The Apple effect. To understand how important Apple has become to Wall Street, consider what happened Wednesday. U.S. stock indexes dropped Wednesday, even though many stocks were up, and the drop is almost completely due to Apple. The tech giant trades on the Nasdaq exchange, but as the world’s most valuable company, it also is a part of the S&P 500 index. Both indexes are weighted by market capitalization, so Apple’s drop of 5 percent hammered both. Interestingly, and to continue the trend we’ve already mentioned, Apple fell not because of earnings or revenue for the second quarter. It was the sales outlook for the third quarter that fell short of projections.

The week ahead. Earnings season continues, with about half the S&P 500 still to report. It’s a fairly quiet week for economic reports, but we will get several that—given the current jitters in the market—are likely to be significant. Today we got the durable goods report for June, which showed a rebound in big-ticket manufactured goods after two months of declines. Tomorrow we’ll get the July consumer confidence report, and on Thursday the government’s first estimate of second-quarter gross domestic product.