Why China's Weighing on the Dow

While turmoil in Europe appears to be the major factor driving down markets today, Asian indexes also dropped overnight, weighing further on the Dow Jones Industrial Average (INDEX: ^DJI) . The Hang Seng (INDEX: ^HSI) declined nearly 2% as the April HSBC/Markit Economics purchasing managers' index came in at 49.1, indicating a contraction in manufacturing. The figure was an improvement over March's 48.3, but still evidence of a slowing Chinese economy.

The news has driven down commodities markets as oil dropped nearly 2% and copper was down more than 2%. The looming austerity measures in Europe have compounded the reaction to China's slowdown, as the EU is its biggest export market.

The manufacturing numbers are just one of many recent reports indicating that China's rocket-like growth is finally losing steam. Its first quarter, GDP growth of 8.1% marked the lowest rate in three years and a drop from 8.9% in the fourth quarter of 2011. That figure was less than economists' prediction of 8.3%. Chinese officials have also shifted toward policies encouraging growth driven internally by consumer demand rather than by manufacturing and exports. Inflation has come with the GDP growth as well as an unsustainable housing boom, and the government has indicated that it will make moves to encourage more bank lending, which should help small-business development and domestic consumption. Beijing has set a target of 7.5% GDP growth for the year.

Not surprisingly, China's manufacturing slowdown has affected Dow cyclicals like Alcoa (NYS: AA) and Caterpillar (NYS: CAT) more than the most. Alcoa is the largest multinational aluminum investor in China, having invested $800 million since 1993. In its first-quarter report released earlier this month, the aluminum-maker reduced its projection for Chinese aluminum demand by 1 percentage point to 11%, down from 15% in 2011. Speaking recently, CEO Klaus Kleinfeld cast doubt on the Chinese aluminum industry, saying much of its production is subject to costs above industry averages and its plans to expand production in western China were likely to disappoint.

Meanwhile, China should factor into Caterpillar's prospects when it reports earnings on Wednesday. The company has 17 plants and nine more under construction in China, its largest market. Overall sales of excavators, a key product category, dropped nearly 50% in that country during March, a concern for some in the construction equipment business (though that figure could turn around by this summer). Caterpillar has lost market share in excavators over the past five years. Also in March, the company said it would expand hydraulic excavator production by 80% in China. At the beginning of the year, Caterpillar had predicted 10% growth in construction equipment demand for 2012. Analysts are expecting earnings of $2.13 per share when the manufacturer reports later this week. That figure would be a 16% improvement over profits a year ago.

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At the time this article was published Fool contributor Jeremy Bowman holds no positions in the companies in this article. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.      

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