Markets Begin Acting Like Markets

 

When China announced a devaluation of the Yuan, it was indicative of a sickness that has been festering in the global equity markets. Growth has been anemic for several years, but equities have generally rallied. The primary contributor has been the generally low level of interest rates around the globe. Today, the Federal Funds rate sits at 0%, with the prospect of a 25 basis point increase before year end. This, coupled with uncertainty in China, is in our view the catalyst of the current market volatility.

Cutler has been advocating that a 10% market correction could be “just around the corner” for several years. This is a normal occurrence for equity markets, but one that hasn’t happened since 2011- over four years ago. Last October, stocks had just over a 9% correction. The culprit at the time? The end of quantitative easing. The end of QE III is a similar factor (monetary tightening) as the onset of 0.25% interest rates. The market will adjust, as it is currently, and ultimately the economy will move forward under these very accommodative policies. The Fed continues to be a stimulus; even with modestly higher rates, we are in a historically low rate environment.

What should investors do? As we advocated last year, ensure that you are in a diversified portfolio. At any given time, certain asset classes may underperform and look unattractive. However, when investments shift leadership, this change can take place very quickly. Timing the market is not a sustainable approach to investing, but understanding your portfolio risk will help you remain invested during times of turmoil. Give Cutler a call if you would like to talk about your portfolio risk at any time.

China Devaluation; Time to Panic?

On Monday evening, the People’s Bank of China lowered the currency peg to the US Dollar by 1.9%. This was followed by additional weakening on Tuesday night, with the two-day move the largest Yuan fluctuation since 1994. Given that China’s currency reserves have been depleted by over US$300 billion this year defending against the rise in the Dollar, this is not entirely surprising. The devaluation immediately makes Chinese exporters more competitive and Chinese assets cheaper in Dollar terms. What does it mean for the US stock market and US multi-nationals? The market reaction has been pronounced, but not severe. The negative response is based, in our view, on two developments: 1) The USD continues to rally, decreasing the value of overseas earnings and hurting competitiveness, and 2) China’s currency movement may portend greater economic weakness in the world’s 2^nd largest economy.

We feel that the latter of these concerns is the greater risk. For much of this century, the Chinese economy was the global engine for growth. This growth, while still in excess of 6%, has abated while simultaneously the US is at the onset of a rising rate environment. We believe that investors should recognize that the Chinese government is showing its determination to maintain growth, at any cost. Such determination may ultimately be successful and greater currency flexibility will allow stimulative monetary policy. Furthermore, the devaluation of the Yuan is deflationary, meaning that if the Federal Reserve was cautious about impending rate increases, they are more so now. We believe that a September rate hike is still the more likely scenario, but the Fed Statement will likely have strong language regarding the cautiousness with which the central bank will proceed.  A Fed fueled rally may still be in the cards.