1 Threat That Could Derail the Dow's Rally

Earlier today, I wrote on how China's recent growth managed to fuel gains in the Dow Jones Industrial Average (INDEX: ^DJI) even though bad banking earnings and downgrades in Europe grabbed most of investors' attention. To further illustrate just how important China has become to the global economy, check out this graphic that shows how quickly China "creates" economies the size of other countries.


Source: IMF. All GDP levels at purchasing power. Includes author assumptions for growth rates going forward set at 8% to 9%.

To think, Greece's economic plight has captured the attention of the entire investing world, but China's economy grows by the same size of Greece's entire economy every 130 days.


The obvious opportunity
China's growth yields obvious opportunities for Western companies, especially the big blue chippers that comprise the Dow. Its insatiable thirst for resources has kept oil high, which benefits ExxonMobil (NYS: XOM) and Chevron. Oil consumption in China rose 6.4% in 2011 while oil consumption in the United States is virtually flat; China's driving the global demand in increases for energy. Disney (NYS: DIS) is planning a new theme park in Shanghai, which will be accompanied by a more dramatic push of its beloved brands into the country. Even though China is in the beginning stages of a broader transformation into a services-based economy, IBM (NYS: IBM) is already seeing big gains in the country. It notched sales gains of 19% in "growth" markets -- which include China -- last quarter, which was a big jump from the company's overall 8% sales growth.

In many ways, Western countries need China to continue growing. Since the fourth quarter of 2007, the United States economy has effectively shown no growth. China has shown growth in excess of 40% during that time. If companies want to continue growing their bottom lines, they need to establish a presence in the countries where the next wave of middle-class consumers is emerging.

Growth to die for
Yet for all the eye-popping statistics surrounding China, it also presents a hidden threat. Consider for a moment the market's jubilation to China's posting growth of 8.9% growth today. Estimates had earlier placed China closer to 8.6% growth. A difference of 0.3 percentage points of GDP is nothing to sneeze at, but we're also at a point in the global economy where fellow emerging economic engine Brazil slowed to 2% growth in its most recent quarter. On the surface, either an 8.6% or an 8.9% growth rate should be sufficient.

However, there's quite a bit that lies beneath the surface when talking about China's economy. For one, you can never be sure about the "accuracy" of GDP growth. For example, it has long been suspected that local banks were fueling a property bubble in part to keep construction flowing that benefits GDP growth -- whether or not the end housing is needed.

Second, 8.9% growth is still quite a bit below the 9.7% registered in the first quarter of last year. That reduction in growth rate becomes especially concerning when you consider that the Communist Party has long formulated economic plans on assumptions that GDP growth would need to be in excess of 8% to preserve social stability.

Welcome to the law of big numbers
That huge economic 8% "required" growth rate might prove to be ambitious as the "law of big numbers" catches up with China. It's a lot easier to grow GDP by 10%-plus when laborers are making $1,000 per year instead of $8,000. However, that doesn't lessen the premise that China does face the threat of an "economic crisis" at growth rates most other countries could only dream of.

Therein lies the challenge in the year ahead. Unlike America, where the "margin of safety" for politicians is trying to keep growth closer to 2%, China's self-imposed margin of political safety is 8%. Anything below that could lead to the government's feared social unrest, or could cause the country to throw good money after bad in an attempt to keep its growth rates up. With a 1.3 billion-strong population eyeing the allure of a middle-class lifestyle, economic danger might be closer to China than investors appreciate.

Take the good with the bad
Still, this is no reason to avoid the blue-chip companies seeing huge growth rates in China if you're an investor. It's just a reminder of why an 8.9% GDP growth rate over "only" an 8.6% rate is so important. Underappreciated growth in China is a great reason to buy several blue-chip companies that have established a strong foothold in the country, but the level of risk they face in the country might be underappreciated as well.

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At the time thisarticle was published Eric Bleeker owns shares of no companies listed above. The Motley Fool owns shares of IBM.Motley Fool newsletter serviceshave recommended buying shares of Walt Disney. Try any of our Foolish newsletter servicesfree for 30 days. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

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