Soft Landing Gear

Brian Hicks

Updated October 4, 2006

A robust trade in Russian-made counterfeit aircraft parts is worrying many in the aviation industry. Emerging markets can help secure a soft landing for the global economy as the US descends from record altitudes, but the components need examining.

Tuesday’s record intra-day and closing highs for the Dow Jones Industrial Average indicate a bullish prevailing wind in the largest of large-cap stocks. This sampling provides a sort of altimeter for domestic sentiment, and despite mixed signals, the economy seems poised for a gradual decline, not a drastic one.

However, the decline does seem to be imminent. If blue chips can stay high, there will be support against a major equity market debacle, but other economic indicators must be considered as well.

Within the past fortnight the Philadelphia and Chicago areas have displayed contradictory inclinations in manufacturing output. Philadelphia’s Federal Reserve general economic index dropped into negative territory, showing that productivity in the vicinity is contracting (slowing). On September 21, when that figure was announced, the Dow and S&P 500 both hit the skids, but registered only modest declines.

This is a positive sign for investor sentiment, which currently rejects a panic reaction.

The next week, a private survey registered unexpectedly high manufacturing orders in the Chicago region, stirred by export demand and lower energy costs.

The US wheels could come off…

US home prices have fallen this year for the first time since 1995. Over the past decade, "flipping" homes became a fairly common practice as buying, waiting for prices to go up, and then selling without having to lift a finger was an amazingly reliable way to turn a simple profit.

By some estimates, housing accounts for 20% of US gross domestic product.

But now, with prices on the other side of the peak, some folks find themselves "upside-down," where the Bernanke-led Fed interest rate hikes have made mortgage payments unaffordable. These homeowners feel the psychological burn in their wallets.

These are not the institutional and large-scale individual investors buying the Dow’s 30 mammoth market-cap component stocks.

These are average Joes and Janes, who have been buying high-dollar items on the basis of equity built into the roofs over their heads. Those halcyon days are over, and the fact that 70% of the US economy is consumer spending means that homeowners are likely to trigger a ripple effect as they return to necessary frugality.

But spending won’t stop, because plastic in the pocket is as valuable as printed paper money to many in this country. Moms and dads and overeager college students can use one creditor to pay off another, "consolidate" debt, and employ myriad other ways to make themselves think that they still have plenty of disposable funds.

That is why there is now a negative average household savings rate for the first time in the history of the United States.

In China, the household savings rate is 40%.

But the Chinese wheels will keep turning

I expect China’s more consumptive and more heavily debt-driven culture of the 21st century to plow forwards with Yankee-style spending habits, for better or for worse.

China’s automobile sales will hit the 7 million mark this year, accounting for 10% of total worldwide sales and likely overtaking the US as the top car-buying country by 2020.

China is also churning out the chariots, surpassing Japan by the end of 2006 to become the world’s #2 auto manufacturer…

But when I was in China last year, I was not able to use a credit card once. It is extremely rare on the mainland to be able to swipe a magnetic strip and buy an airplane ticket, much less a burger. Here in the States, I laid my bets down on the beginning of the end when McDonald’s began accepting plastic.

The trend is creeping into the Middle Kingdom, though, and Chinese banks that list in Hong Kong, London and New York are among the most attractive and heavily-bought Chinese stocks. Because as consumer society grows, so does the hunger for credit.

And when credit grows, consumers find that their eyes are often bigger than their wallets or stomachs can handle. Welcome to a new generation of international consumer debt.

Santa Claus Has a Charge Card

Though Wal-Marts and Targets are full of Chinese-made goods, China’s export markets are not likely to suffer even if Americans were to slow down their spending. Since most Chinese products sold in the US are of low cost, the less disposable income in one’s wallet, the more likely he or she is to buy a Chinese alternative to their preference. The Chinese are now in a position to buy Rolexes with their new upper-middle class, but most of what they sell is far from Swiss precision.

Consider the toy industry, whose segment of the Dow Jones Global Industry index has surged by over 18% since the end of June. The Christmas shopping season is coming up, leading us back to the perennial trend of emerging markets feeding US consumption.

Even if the US economy plummets down to the ground, some trends and markets will keep flying high while new ones take off.

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