Here’s Why Global Markets are Panicking Right Now

What the hell is going on in China?

That’s what everyone at the World Economic Forum in Davos wants to know. Clearly the markets are wondering the very same, as world equities plunged Jan. 20 and U.S. stocks neared bear market territory.

There are a lot of reasons for this, many of which you can find packaged here and here. The short of it is a toxic brew of: the fact that central bank easy money has been artificially buoying markets for some time now, coupled with a slow down in emerging markets (led by China), and a lackluster U.S. recovery. But there are newer reasons for the market turbulence, including a number of companies reporting less-than-stellar earnings. Most important are all the new and conflicting data points coming out of China.

In many ways, what we’re witnessing could be called a “Tale of Two Chinas.” First, the dismal story: There’s a debt bubble of epic proportions in China, and it’s bursting. As the Institute of International Finance numbers released Jan. 20 show, this has resulted in an even bigger capital outflow from China than was previously thought. Some $735 billion left emerging markets last year, and all but $59 billion of it was from China. Do the math and let the mind-boggling size of that figure simmer for a moment. Investors are clearly voting with their feet, and markets are reflecting that. Oil, meanwhile, is moving lower on not just China weakness, but also on more capacity from Iran, and a general lack of demand in the global economy.

I, too, have been fairly pessimistic about China, in large part because its politics are so opaque and its policy decisions have been so unsettled of late. And yet I have to be fair and say there is another way to spin the story if you look closely at the data.

Falling demand for commodities reflects a slowdown, yes. But it also reflects the fact that China is rebalancing away from being the world’s factory, toward a more consumption-driven economy. White collar office buildings use less coal and oil than big factories. Andy Rothman, an investment strategist for the fund management firm Matthews Asia, and a long-time, respected China watcher, wrote in his newsletter today, “China’s old economy was weak last year, and that will continue this year, especially in heavy industries such as steel and cement, as China has passed its peak in the growth of construction of infrastructure and new homes.” Yet at the same time, he points out, the consumer story is stronger than it looks. “Few investors recognize that 2015 was the fourth consecutive year in which the manufacturing and construction part of the Chinese economy was smaller than the consumption and services part. Consumption accounted for about two-thirds of GDP growth, illustrating that the economy has rebalanced away from a dependence on exports, heavy industry and investment, and has, in my view, become the world’s best consumption story.”

If this is so, it would indeed be good news: The only thing that will save the global economy in the short-term is more demand. But it must be said that government investment in China is still a much larger part of the economy than the consumer sector. Indeed the government investment as a percentage of the economy in China is bigger than it’s been anywhere—ever. (Yes including post-war Europe, Japan or the U.S.) China is where the debt bubble is. And as statistics show, when you run up debt fast, it always ends in tears.

This is what markets are trying—in their helter-skelter way—to price out right now.

There’s another wild card, one that’s being discussed in more and more detail in Davos at the annual World Economic Forum which opened Jan. 20. What if Donald Trump were to become president? It’s a big worry for global investors, particularly in the context of China. The last thing that markets need right now is a guy that wants to build walls (literally and figuratively) rather than bridges with the rest of the world. One investor here in Davos, Anthony Scaramucci of SkyBridge Capital, told me that he had two growth and market scenarios for the U.S.—one if Donald Trump became president, and one for every other candidate in the American presidential race. No prizes for guessing which one is much less bullish. “Trump would be a disaster, not only for foreign direct investment in the U.S. from the Middle East, but also for the U.S.-China economic relationship,” he says. “You’d have this perception that American is closing up for business.”

Of course, slower growth and more polarized politics go hand in hand. Stay tuned for more from Davos.