The data points range from the obvious to the obscure, encompassing stock market and credit bubbles in China, the strength of the dollar relative to emerging market currencies, a commodity rout and a sudden halt to global earnings growth.
While it would have been impossible to predict the precise timing of the last week’s downturn, this array of economic and financial indicators led to an inescapable conclusion, these analysts say: The United States economy would only be able to avoid for so long the deflationary forces that have taken root in China.
And if the bull market had made it to April, it would have become the second-longest equity rally in United States history. The one common theme binding all these measures together is the risk that they pose to the economic recovery in the United States.
The Federal Reserve has said that it expects to raise interest rates sometime soon, given evidence over the last year that economic growth is picking up. But more and more analysts are now pointing to problems in China and other markets as posing a real threat to the American economy.
“The global G.D.P. pie is shrinking,” said Raoul Pal, a former Goldman Sachs executive, now based in the Cayman Islands, who produces the Global Macro Investor, a monthly financial report that caters to hedge funds and other sophisticated investors.
Of the hundreds of indicators that Mr. Pal follows, the most crucial over the last year, in his view, has been the relentless upward move of the dollar against just about all emerging-market currencies. The dollar rally began in January 2014, when the Fed signaled that it would raise interest rates.
But the greenback’s strength against currencies like the Russian ruble, the Turkish lira and the Brazilian real began to gather steam a year ago.
Veterans of past emerging-market booms and busts will tell you that the party always ends — as it did in Latin America in the 1980s and Southeast Asia in the 1990s — when the dollar takes off against these monetary units. Suddenly, loans in relatively cheap dollars that financed real estate and consumption booms were no longer available and the ultimate result was always a growth slowdown.
Any discerning investor could have taken note of this trend. For example, through the year ending on Aug. 19, the worst-performing investments in dollar terms were the following, according to Merrill Lynch: Brazilian equities, down 45 percent; Russian bonds, down 43 percent; Indonesian equities, down 26 percent; Turkish and Korean equities, down 25 percent; and Mexican equities, down 22 percent.
During this same period, United States equities returned 8.7 percent — the fourth-best return delivered by any major class of assets. In effect, investors in the United States were saying that what happened in Russia, Turkey and Indonesia need not have any effect on stocks of companies based in the United States. This would turn out to be a major miscalculation. What was driving weakness in all these countries was the gradual slowdown in the Chinese economy.
As China bought less steel from Brazil, iron ore from Australia (its stock market was down by 22 percent during this time frame) and less mineral fuel and oil from Indonesia, the effect on these economies was immediate. When it comes to warning indicators from China, there are many from which to choose.
One is that, according to their 2014 balance sheets, four out of five of the world’s largest banks are Chinese. Or one could choose the Chinese debt ratio, which McKinsey & Company has estimated to be over 280 percent of the country’s total economic output.
But for Albert Edwards, a strategist at Société Générale in London, what really confirmed in his mind that the Chinese growth engine was sputtering to a halt was the government’s naked support of the country’s stock market bubble. Among the government interventions were lending state entities money to buy stocks and restricting shareholders from selling large positions.
Before the market collapsed, Chinese stocks reached a market capitalization of close to $ 10 trillion — making it the second-most valuable exchange in the world. “Once you encourage an equity bubble, it will collapse — and then you are really in trouble,” Mr. Edwards said.
“This was utter madness.” Long before China’s decision to devalue its currency this month, Mr. Edwards said that it was the sharp reduction in value of the Japanese yen against the dollar in autumn 2014 that also set off alarm bells.
Because Japanese exports compete aggressively with currencies in Thailand and Korea, this was, in effect, a precursor to the Chinese currency move. He also noted that one of the causes of the Asian emerging market crisis in 1997 was that countries in the region broke their peg with the yen. “It just rippled across the whole region,” he recalled.
The bottom line though, is that investors in American stocks recognized too late in the game that a global contraction was sneaking up on them.
For Jeffrey Sherman, a portfolio manager at the bond investment firm DoubleLine, the big cautionary sign was the correction in the high-yield corporate bond market. In summer 2014, as stocks of United States companies continued to push upward, the yields on risky corporations started to spike.
As many of these companies were in the energy sector, mostly digging for shale oil, they were hard-hit by the sharp drop in oil prices. Still, the fact that these bonds were entering their own bear market should have been seen by equity investors as a warning sign, Mr. Sherman said.
“These bonds have been very weak,” Mr. Sherman said. “There has been a huge divergence between high yield bonds and the stock market.”
Taken together with slow growth in China, the result, as he sees it, is that the outlook for growth in the United States is extremely fragile and not in a good position to survive an increase in interest rates from the Fed. David A. Stockman, a former budget director under Ronald Reagan, has spent the last three years closely examining the excesses of the Chinese investment boom and warning on his contrarian blog of their consequences.
He points out, for example, that in the late 1990s, China had the capacity to manufacture 100 million tons of steel. That figure today is 1.1 billion tons — almost twice the amount of annual demand for steel in China.
The China steelmaking boom also sent the price for iron ore up to nearly $ 200 a ton in 2011, from around $ 30 in 2008.
Like all commodity prices, it has fallen sharply, to just under $ 100, a correction that creates problems for big iron ore-producing countries like Australia, which made huge investments to keep supplying these raw materials to China.
“Iron ore is the canary in the steel shaft if you will,” Mr. Stockman said. “It is a real measure of the violence of global deflation that is currently underway.”
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