5 Reasons China Has U.S. Investors Worried

The question on the minds of many economists and investors when it comes to China is simple: If the world's most populous country sneezes, does the world catch a cold?

The S&P 500, the primary stock index professional money managers track, is up only about 1 percent since the start of the year, amid growing concerns about the second-largest economy. Companies as diverse as Caterpillar (CAT), a maker of construction and farming equipment, retailer Macy's (M) and Yum Brands (YUM), the parent of KFC and Taco Bell, have blamed problems in China for hurting their profits.

This represents a change for multinationals, which had been attracted to China in recent years because it offered the potential for growth they can't get at home.

Let's take a closer look at what has investors so riled up.

Currency swing

Politicians of all stripes have complained for years that China keeps its currency, the yuan, artificially low to undercut competitors in other countries including the U.S. Earlier this week, officials at the People's Bank of China allowed the yuan to fall 2 percent compared with the U.S. dollar, the largest devaluation in almost two decades. The currency had strengthened along with the U.S. dollar in recent months, which hurt Chinese exports.

In a note to clients today, Eurasia Group called the devaluation "a smart political strategy" because it enabled the People's Bank "to be more responsive to growing domestic pressure to defend growth in light of worrying data out of China ... while also making progress in reforming the currency's valuation mechanism -- a key financial reform agenda item."

A note from High Frequency Economics urged investors not to panic. "On January 6, 1994, China devalued the yuan by 50% in one day, a shock big enough to trigger competitive devaluations around Asia," the note said. "Possibly this was one of the triggers of the 1997 Asia crisis. This is not that."

Slowing growth

Investors first began to worry about a slowdown in the Chinese economy in 2012, when it cut its growth target for the first time in eight years as the government recognized "that its double-digit growth rates are past," according to the Financial Times.

Keep in mind that China's economy is still growing at a much faster pace than most of the rest of the world. It's forecast to increase 6.8 percent in 2015, well above the 3.3 percent gain expected for the worldwide economy and the 2.5 percent forecast for the U.S., according to the International Monetary Fund. That forecast, however, is below the 7 percent target set by the Chinese government. When Chinese exports plunged 8.3 percent in July, it further heightened investors' growing anxiety about China.

China in the U.S.

The ties between China and the U.S. run deep. According to the Office of the U.S. Trade Representative, U.S. goods and services trade with China totaled $579 billion in 2012, the latest data available. China is America's second-largest trading partner and the No. 2 holder of U.S. Treasury securities behind Japan, totaling $1.47 trillion, down from $1.65 trillion in 2006, according to Bloomberg. It has been selling U.S. government debt in recent months.

China's tumbling stock market

In the wake of June's stock market crash, the Chinese government has tried to bolster stock prices by clamping down on short-selling, banning corporate insiders from unloading shares and forcing state-run institutions to bolster the market with equity purchases. According to Bloomberg, the Chinese stock market is no longer the world's most liquid and continues to slump. In fact, Hong Kong's Hang Seng Index has plunged more than 12 percent over the past three months, unnerving investors even more.

Impact on the U.S.

Many U.S. investors hold shares of multinationals that do business in China through their 401(k)s and in Chinese companies directly such as Alibaba (BABA), which today reported disappointing results. Trouble in China raises the question of whether it will cause the Federal Reserve to delay raising interest rates, which it has kept artificially low. Economists who closely track the Fed's moves don't think that will be the case, at least for now. Many expect the increase to come in September.

"While the depreciation of the yuan increases the uncertainty around the upcoming FOMC (Federal Open Market Committee (FMOC) meetings, at this point it does not lead us to fundamentally shift our expectations for liftoff in September," according to BofA Merrill Lynch, adding that the Fed remains watchful of the data and will move accordingly. "We thus recommend paying close attention to upcoming speakers to see how they assess the risks to the Fed's objectives and expected policy path from this regime shift in China."

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