• Investing & Markets

Market Recap – China Rattles Markets By Devaluing The Yuan

August 14, 2015 | Craig Birk, CFP®

Market Digest – Week Ending 8/14

China rattled markets by devaluing the yuan, but US stocks still finished positive for the week. This may have been driven by a belief that a weaker Chinese currency would give the Fed incentive to keep rate increases on ice, but bond prices were little changed. Eurozone leaders agreed on a new $96 billion bailout package for Greece. US oil prices hit a six year low.

Weekly Returns:

S&P 500: 2,092 (+0.7%)
FTSE All-World ex-US: (-1.1%)
US 10 Year Treasury Yield: 2.20% (+0.04%)
Gold: $1,114 (-1.8%)
USD/EUR: $1.111 (+1.2%)

Major Events:

• Monday – Berkshire Hathaway agreed to buy Precision Castparts for $32 billion, its biggest deal in history.
• Monday – Adobe Systems announced generous maternity and paternity leave policies, a week after Microsoft and Netflix did the same.
• Tuesday – China lowered the yuan’s trading range against the dollar by 1.9%. Global stocks fell as investors worried the move signaled weakness in the Chinese economy.
• Tuesday – Greece and its creditors agreed to a new $96 billion bailout package. The agreement would ultimately be ratified on Friday, but political dissention about the program remains both inside and outside of Greece.
• Wednesday – Former President Jimmy Carter, 90, announced he has cancer and would provide more information on his condition later.
• Thursday – Edward Jones agreed to pay $20 million to settle SEC charges that it improperly sold bonds to customers at artificially high prices.
• Thursday – HBO purchased rights for the first airing of Sesame Street, in an escalating content war surrounding children’s shows.
• Friday – The U.S. government said it would allow trade of American oil with Mexico, a further erosion of the nation’s four-decade ban on selling oil overseas.

Our take:

The sharp drop in Chinese equities over last month isn’t particularly relevant on its own, but the pace of the slowdown in China’s economy will be very important to the global economy. Chinese government moves this week to devalue the yuan suggest things may be worse than many have anticipated. By letting the currency drop, it will boost the competitiveness of Chinese exporters, which is the likely rationale. In the very long run, it should be a positive if the yuan is allowed to float more freely and is more market driven. But for now, if Chinese growth drops faster than expected or into negative territory, it will create a serious headwind for the global economy and could cause global stock indexes to decline. But it is just one factor.

Even if China finds itself with its own financial crisis driven by bad debt (which we believe is a high probability, although the timing is unknown), we do not believe there is unusually high risk of a 2008 “Lehman” type moment or sharp, severe stock crash in developed markets. Western banks have very little exposure to Chinese debt and very little interaction with Chinese banks. The reason 2008 was so volatile is because the major banks didn’t know if the other major banks would be able to make good on their arrangements. This caused a massive liquidity freeze. Within China, a debt crisis could be very bad, but the government has ample reserves to help protect against it. More importantly, it should not significantly impact western banks.

We think there was an overreaction regarding the impact to US companies that sell to the Chinese consumer market. For example, Apple dropped 5% on Tuesday when the devaluation was announced, but recovered much of that loss later in the week. China is a very important market for Apple, and a lower currency directly translates to less revenue in dollars. But a slowdown in China will simply slow growth there, not stop it. The big picture for Apple and other consumer facing companies doesn’t change. For materials and commodity producers on the other hand, financial problems in China could be much more painful.

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