After a six-and-a-half year bull run, the U.S. stock market experienced a dramatic correction over six trading days in late August. It was quick and sharp, leaving the Dow Jones Industrial Average at 15,666 on Aug. 26, 14.6 percent below the market top of 18,350 recorded in May and shown in the top chart. The correction was long overdue as rising stock prices had outpaced the growth of underlying corporate earnings. In the days that immediately followed, a bounce back temporarily recovered about a third of the market’s lost value before heading downward again.
The proximate cause of the U.S. sell-off was rising investor concern about the economic slowdown in China and the seeming chaos in their financial markets. China’s manufacturing output has declined for four consecutive years, causing the government to devalue its currency by 2 percent in an attempt to make its exports more price competitive and to temper further declines. Investors particularly fear that the currency devaluation may signal that China’s economy is in poorer condition than what was assumed.
A second reason was the perception that the Federal Reserve Bank would begin increasing interest rates, starting in September. The World Bank and the International Monetary Fund have continuously asked the Fed to postpone any increase until 2016 to cushion further disruption to faltering global economies. Many are in recession having seen deep declines in their equity markets, devaluations of their currencies, and precipitous outflows of their capital.
The U.S. stock market will need time to absorb the initial shock of the correction and is apt to drift lower this fall. The market will remain volatile as it reacts to China’s ongoing financial woes and to the contraction of other economies that rely heavily on exports to China. This global spillover may also cause the drifting U.S. stock market to test its recently established lows.
China’s Slowing Growth Rate
The triggers causing the U.S. stock market correction are mostly reactions to global financial conditions and are external to the health of the U.S. domestic economy.
The declines in China’s stock market, down 43 percent from its June peak on August 26 (bottom chart), are rooted in its own economic slowdown, however slight. Consensus estimates show annualized GDP growth dropping from 7 percent to 5 percent. By any measure, that is still a very healthy rate of growth.
Another trigger was the over-bought condition of China’s stock market. Last year, stock market prices skyrocketed as millions of Chinese people—encouraged by the government—opened brokerage accounts for the first time. Individual investors took heavy losses in the recent crash.
Even more curious, Chinese government entities recently spent trillions of dollars buying equities in order to prop up markets that were already considered significantly overpriced. China’s central bank has lowered interest rates five times since November and has also lowered reserve requirements for banks several times since February to encourage more lending.
These monetary strategies are meant to prop up financial markets as China continues to rebalance from a manufacturing, industrial, and construction-based economy to a more consumer-driven economy. More governmental intervention should be expected as conditions so warrant.
China is the second largest global economy and accounts for 15 percent of the world’s economic output. The country has the financial resources to successfully accomplish the transformation but the question is whether it also possesses the political will. The transition is occurring at a slower pace than hoped. Many initiatives have been successfully implemented but the next steps that are required, including the formation of more small businesses and a healthy middle-class with greater disposable income, calls for new, bold social policies. Chinese leadership may have underestimated this undertaking.
The spillover effect from China’s manufacturing decline has had an outsized impact on developing nations that rely on the export of commodities to China, as well as on its industrialized trading partners such as Germany and Japan. Fortunately, the U.S. economy is largely fenced off from the impact of China’s economic woes, the exception being some U.S.-based multinational companies which will experience losses in global revenues and shortfalls to their projected profits.
U.S. Growth Set to Accelerate
Although projected growth rates for the U.S. economy may be slightly impacted by volatile global stock markets, there is nothing visible that could derail the current economic trends, which are strong and expected to accelerate this fall. The United States is in the middle of an economic expansion and has reached a point where growth momentum is now sustainable, no longer requiring financial stimulus from the Fed. There are likely two more years of economic expansion ahead before the maturity phase of the current economic cycle is reached. Metaphorically speaking, we are likely in the seventh inning of the cycle.
The recovery from the Great Recession has been solid, but not great. Employment growth is still tepid, but housing is back and getting stronger each quarter. Consumer spending is also improving, bolstered by low gas prices. Revenues and profits for businesses are robust and are expected to further strengthen in the third and fourth quarters. Their bottom-lines are aided by lower oil and natural gas prices. Interest rates are historically low and financing is readily available.
Most economic metrics have green lights. The most watched variable will be for any spillover effect from the global downturn which could slightly temper U.S. growth rates. The U.S. economic expansion should continue to track on trend.
Strong Operating Metrics
Metric for metric, lodging operations are at modern-day highs and expected to trend upward for perhaps two more years before moderating. 2015 is on pace to record the highest occupancy rate in over 20 years. The rate of future demand growth will begin to slow as guestroom demand starts to bump into natural booking constrictions caused by holidays, normal convention and business meeting periods, and seasonal travel preferences. For particular hotels and markets, it is very challenging to create new guestroom demand where regular demand does not already exist, thereby resulting in a natural topping out of demand growth.
Over the next few years, leadership in the room revenue/RevPAR equation will pass from occupancy growth to gains in average daily rate. With the moderate pace of the construction pipeline it will be at least another 2.5 years before annualized supply growth reaches 2 percent.
The industry has delivered five consecutive years of double-digit profitability growth. Depending on the economy, the lodging industry could operate at these peaks for two more years before topping out. We will then enter the maturity phase of the cycle where the future growth rate of lodging metrics, except for new supply, will slow as the economy softens and the cycle eventually drifts downward. But for now, we are likely only halfway through the expansion phase of the lodging cycle and are in the midst of a “golden era” for the hotel industry.
Patrick H. Ford is the president of Lodging Econometrics.
