The No. 1 Threat to the Dow


The Dow Jones (INDEX: ^DJI) roared back at the close of trading yesterday, ending largely flat. Today that situation is basically unchanged; the index is up 0.20% as of 11:10 a.m. EDT. Europe, which had plunged yesterday and closed before encouraging Greek chatter led to a Dow rebound, saw its fortunes turn back positive today. The FTSE 100 (INDEX: ^FTSE) is up 1.73%.

A holding pattern for the Dow
Markets seem to be in a holding pattern for the time being. Greece hangs on the edge of leaving the eurozone, but a few weeks of selling have already taken their toll on indexes across the world. Gains from the past year have been erased, and events that are normally widely followed (like today's jobless claims number) feel like a minor sideshow to the main event that is Europe.

A bigger threat to worldwide markets?
However, while investors have laser-like focus on the situation in Europe, another landmine lurks. Headlines have begun focusing on China mulling a fiscal stimulus. Most of the articles around China and a possible stimulus focus on quotes from its leadership, the most pre-eminent of which was Premier Wen Jiabao saying the country wants to foster "stable and relatively fast growth."

There are a couple of key problems in this situation. China's trade surplus, a key factor in its economic growth, is eroding. Rising commodity imports and trade with Europe falling off a cliff -- which has been a larger source of exports than the U.S. -- are both factors here. The second major problem is that China can only continue fueling growth through infrastructure build-outs for so long.

China is aware of this
At the recent annual CFA conference, the best speech from a grouping of very influential financial thinkers came from Michael Pettis (you can find his blog here). In a nutshell, he's one of the leading economists on China and its need to rebalance toward a consumer-oriented economy. As a professor in China currently, he spoke of government officials and economists understanding the dire future consequences if the country can't boost its historically low share of consumer spending.

However, while China's leadership appears aware of this problem, they're also hemmed into a situation where it's believed higher growth is necessary to maintain social stability. The fear is that a rapidly worsening situation in Europe would cause growth to become depressed even more and force China to take larger fiscal actions to keep its GDP elevated.

That kind of action might present great headlines for investors: "China supports global growth, moves to boost demand!" But if the country pours more money into infrastructure and other investments, it could be worsening its long-term situation, perhaps dramatically. In the long run, those kinds of investments, if made poorly, would continue building debt throughout China's opaque local governments and banking system -- all with ugly long-term consequences.

Is it all doom and gloom?
The end scenario for China doesn't have to be doom and gloom. It's just important for the country to not put GDP figures at a premium, and rebalance toward consumer spending instead. A GDP reading of 2% growth might cause panic, but if it's tilted toward much more household consumption, citizens in the country will actually be much better off. Also, U.S. corporations who supply consumers -- you know, companies like Coca-Cola (NYS: KO) and McDonald's (NYS: MCD) -- will be much better off. Infrastructure companies like Caterpillar won't fare as well, but in aggregate this is the best scenario for blue chip Dow companies with great brands.

Adding it all up
The key takeaway for investors is to remember that while Europe is hogging all the headlines, its story can affect many other dominos in this global economy. That doesn't mean you need to panic and sell all your stocks, but it does mean investors need to be keenly aware of the effects actions like Greece leaving the eurozone could have well beyond the borders of Europe.

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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 Coca-Cola. Motley Fool newsletter services have recommended buying shares of Coca-Cola and McDonald's. The Motley Fool has a disclosure policy.
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