A sign board displaying Toronto Stock Exchange (TSX) stock information is seen in Toronto June 23, 2014.Mark Blinch/Reuters
Will the fallout in Chinese stock markets ripple through to North American stock markets?
In terms of future market action in North American equity markets, it is not China's plummeting stock markets that have investors concerned, it is the question of potential slower Chinese economic growth. Investors do not like uncertainty and what we have is uncertainty in China's economic health. China is just one additional concern weighing on investors' minds.
While the Chinese market bubble appears to have burst, this does not necessarily spell dire consequences for North American equity markets. It is unclear whether the fallout in the Chinese equity markets will have a material negative impact on future GDP growth for the country and if companies in North America will impacted.
While China's economic growth is high, it has also been contracting for the past four years, and may slip below 7 per cent. For Canadian investors, a slowing Chinese economy has implications for two main sectors in the S&P/TSX composite index, the energy and materials sectors.
Energy Sector
The price of oil has a number of factors that are drivers for the price of oil. China is one factor, as the country is the world's second-largest consumer of oil and for that reason, slowing Chinese economic growth has negative implications for oil demand. However, the price of oil also has pressures from the strengthening U.S. dollar, the potential of a nuclear deal with Iran, reports of OPEC reporting strong oil production, rising U.S. oil inventory levels, and U.S. oil rig counts climbed last week, for the first time since December.
Despite Chinese markets collapsing with the Shanghai Stock Exchange composite index down 5.9 per cent, the price of oil was stable when North American equity markets opened on Wednesday. The price of oil plummeted at 10:30 a.m. on Wednesday, after the U.S. Energy Information Administration surprised the Street and reported a build in oil inventories. The news sent the price of oil below U.S. $51, which later recovered some of its losses. Furthermore, on Monday, the price of oil dropped over 7 per cent, after results from the Greek referendum drove the U.S. dollar higher. On Tuesday, the price of oil intraday, dipped down to nearly U.S. $50.50, on speculation that nuclear talks with Iran were progressing, raising speculation that a deal may occur after the 'soft' deadline was extended to July 10. In other words, the price of oil has many different drivers.
As we enter the second quarter earnings season, energy stocks may remain under pressure. They lack catalysts to drive stock prices higher. According to a report by FactSet, of the ten sectors in the S&P 500, the energy sector is anticipated to report the largest year-over-year decline in sales as well as in earnings.
Given these concerns extending beyond China, this sector is likely to remain depressed and underperform the index in the near-term. At some point, I believe merger and acquisition activity may percolate investor appetite for energy stocks, but believe it is premature to be making a shopping list of energy stocks to buy.
Materials Sector
China is a major consumer of materials and is the largest consumer of copper. The copper price was down sharply on Wednesday along with Canadian companies with copper exposure. Many analysts have been revising their revenue estimates down. I recommend avoiding stocks with negative revisions and continue to remain bearish on many of these resource stocks.
Here's the bottom line:
It is a stock pickers' market and once there is clarity on overseas issues, markets will find some stability and the volatility should ease. For now, markets will remain volatile but can create buying opportunities for investors.
Investors should look forward to the upcoming earnings season. How long-term investors can make money is by avoiding stocks with negative growth and negative revisions. Investors should build and maintain a diversified portfolio of companies that are actually delivering solid growth, that report positive earnings surprises and have positive revisions by analysts. Also, focus on investing in stocks that are relatively independent to what is happening overseas. As I have said before, I do not like to catch a falling knife; however, there will be some attractive opportunities emerging. For now, I would continue to avoid resource stocks.
Jennifer Dowty, CFA, Globe Investor's in-house equities analyst, writes exclusively for our subscribers at Inside the Market. Email any sock suggestions that you want profiled to jdowty@globeandmail.com