When China’s central bank cut interest rates on November 21 investors from Asia to the United States celebrated by driving stocks higher across all continents. While there had been talk of a rate cut for some time, the cut was held up by a policy disagreement.
The move comes as China’s economy has slowed dramatically from its torrid pace it was on during the first decade of this century. As a result, the Peoples Bank of China made the decision to cut rates in order to lower the borrowing costs for corporations in particular. Most experts believe there will be more cuts to come and the next one could come as early as the first quarter of 2015.
While investors celebrated initially, you also have to consider what the Chinese central bankers see going forward that warranted the move. If the Chinese economy continues to slow and actually goes into a recession rather than just experiencing slower growth rates, the entire global economy would suffer. China has the second largest nominal GDP in the world behind the United States. When the U.S. enters a recession, most of the rest of the world typically follows. The same would happen should China enter a recessionary period where GDP was actually contracting.
While the central bank took preventative measures by cutting rates, there is no guarantee that cutting rates will boost spending and growth. Just look at the low interest rate environments of Japan and the U.S. over the last decade if you doubt that last statement.
Japan’s benchmark rate has been below 0.5% since September 1995 and it has been at 0.0% since October 2010. Yet even as the central bank of Japan has held interest rates down for almost 20 years now, the economy has gone through several recessionary periods. In fact, the GDP for Japan has shown contractions in three of the last four quarters.
The U.S. Federal Reserve mad the move to cut the benchmark rate in this country to 0.25% in December 2008 and yet over the last six years, the GDP has only shown growth greater than 3% in two of the 24 quarters. Yes the economy has been growing for the past five years, but it isn’t exactly growing rapidly.
The point is that while investors may have been encouraged by the rate cut, you need to keep things in perspective. The rate cut might not be enough to keep China from going into a recession and the Chinese economy could look much like that of the U.S. or Japan for the next few decades. If that is the case, the world stock markets could be in for a rough couple of decades.
With that being said, should the rate cut work and both corporate and personal spending increase, there are certain companies and certain industries that will benefit more than others. Three particular industries that should do well are consumer goods, industrials and technology. Industrial firms would benefit more from an increase in corporate spending, consumer goods would benefit more from an increase in personal spending, and tech firms could benefit from both the corporate and personal spending.
If you look at the most popular US companies in China, Caterpillar (NYSE:CAT) and Boeing (NYSE: BA) are there and both are in the industrial sector. Among the more popular consumer brands are YUM Brands (NYSE: YUM), Pepsi (NYSE: PEP), Coca Cola (NYSE: KO) Starbucks (NASDAQ: SBUX) and Nike (NYSE: NKE). The top three US tech companies in China are Microsoft (NASDAQ: MSFT), Intel (NASDAQ: INTC) and Apple (NASDAQ: AAPL).
Should the rate cut have its desired effect on the Chinese economy, the three sectors and the companies listed above may benefit the most. Another possible benefactor of the rate cut should China’s economy take off again would be the basic materials industry. Products like silver, coal, copper and oil will be in greater demand and that could drive prices back up.
While the initial move by investors was a knee-jerk reaction, you have to think more long-term and evaluate which companies and industries will benefit the most. You also have to think about what happens if the rate cut doesn’t have the desired results. What happens if the central bank actions of China meet with the same success as the US Federal Reserve or worse yet, the Bank of Japan?
