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Overseas Markets Might Add Spark to U.S. Economy

Strength in China and a weaker dollar could help reboot the U.S. manufacturing sector.

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Over the past several weeks I have written about the U.S. consumer being a bit weaker than I had hoped, but I've noted that U.S. export opportunities were helping to offset some of that weakness. This trend looks set to continue as a stronger-than-expected Chinese economy and weaker dollar bode well for export opportunities for the U.S.

Generally, I have focused on the U.S. economy, but I think it's important to mention some international activity given that S&P now believes almost 50% of all revenues from S&P 500 constituents come from non-U.S. sources. Interestingly, both the Chinese markets and the U.S. markets were weaker at the end of August, as fears grew that China would pull back on some of its stimulus efforts. The Shanghai Composite was down over 20%, as some began to worry that China was going to be restricting bank loans going forward. U.S. stocks were down far less, but the China shock did put a temporary damper on the U.S. market.

This week China announced that bank loans were actually up 15% from July to August, and stocks rallied. Just as importantly, China's premier announced on Thursday that he felt the Chinese economy was still in a delicate position and that the government wasn't going to remove any stimulus just yet. Most other Chinese statistics announced this week were positive, including industrial production and retail sales all showing healthy growth. Exports, however, remained quite weak. The beneficiaries of a stronger Chinese economy are the U.S. capital goods manufacturers that help build out Chinese infrastructure, electronics companies that ship consumer electronics and computers, and to a lesser degree U.S. agriculture.

The strong dollar has also been a bit of a drag on the economy and individual companies. I hope these effects will begin to reverse themselves in a big way in the fourth quarter. Although a strong dollar is generally viewed as a good thing, a weak dollar actually helps U.S. companies sell more goods overseas, and foreign currency received for those goods translates into more dollars for reporting purposes.

When the dollar appreciated almost 18% from its low in July 2008 to its high this spring, a huge head wind was created for a broad swath of consumer goods companies. Since this spring, the dollar has declined almost 8%. The strong dollar was a result of a flight to safety during the worldwide financial collapse last fall. As markets have begun to assume more risk, the dollar has backed off. Barring another crisis, the dollar will be down on a year-over-year basis sometime in the fourth quarter.

The overall trade deficit was $31.96 billion in July, up from $27.49 billion the previous month (resulting from a 2.2% growth in exports and a 4.7% increase in imports). But the deficit was well below the high-water mark of over $64.89 billion. Ironically, the "Cash for Clunkers" program drove up sales of imported cars as well as domestically produced cars, causing the trade deficit to jump. Oil imports were also an important factor in the month-to-month increase.

Corporate Upside
Good news continues to pour in from individual companies with both  FedEx  (FDX) and  Texas Instruments (TI) beating or raising expectations. One of my biggest worries during this recession has been that the big transportation companies had yet to show much improvement, given that they have generally been a leading indicator for the economy. Friday, FedEx announced surprisingly good results. Management now expects earnings for the August quarter of $0.58 per share versus guidance of $0.30-$0.45. The company cited strong results for one of its international products. It also raised guidance for the November quarter, though results will still be down from last year's very strong period.

Texas Instruments also raised its revenue guidance for the current period. This confirms a series of strong announcements from semiconductor companies including the largest U.S. chip producer,  Intel (INTC). Generally, strong June quarter figures were a result of replacing dangerously low inventories. Stronger guidance for the September quarter seems to be a result of some large computer companies ramping up production in front of a new operating system from  Microsoft (MSFT) expected in October. I hope to see this inventory restocking phenomenon continue across a broader range of manufacturers over the next several months.

Credit Flow
Finally, on the credit front, there seemed to be good news from companies that were trying to become less dependent on their banking relationships and/or finding alternative sources of capital. Market research firm Dealogic noted that $2 trillion had been raised in European bond markets so far this year, 38% ahead of last year's levels at the same time. These issuances came from a wide variety of industries, with some of the bonds being used to replace bank debt.

It was also reported this week that China's sovereign wealth funds were planning to partner with U.S. private equity firms to buy distressed real estate and real estate securities. Over the past several weeks, the commercial real estate market has been one of my growing concerns. This may be yet another outlet to ameliorate some of our U.S. banking problems.

On Tap
Looking to next week I am expecting the data from the Philly Fed Index and the Empire State Manufacturing Index to show continuing strength as the auto industry continues its large production ramp-up and as other manufacturers begin to restock inventories.

The always-nettlesome retail sales report is also due next week. Strong auto sales should manage to create strong headline growth numbers, but I imagine it won't take the press long to strip out the auto numbers to show continuing lethargy in non-auto-related sales.

Housing starts are also due next week, and I expect continued improvement, perhaps close to the 600,000 level, but still well off its high of over 2 million units.

See More Articles by Robert Johnson

Robert Johnson, CFA does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.