The ongoing uncertainty emanating from China could continue to push investors into safe havens at least until the Federal Reserve meets on September 16th-17th. I believe the market conditions in China warrant further watching beyond September.
China unexpectedly devalued its currency in August as the world’s second-largest economy cools. While market participants have said the country’s moves should have a small impact on the U.S., questions remain as to what other measures, if any, China may take. One of the questions driving this uncertainty is what the impact of further Chinese stimulus will be.
By devaluing the yuan as growth slows, Chinese officials have added disinflationary pressure to the global markets. For the U.S., where inflation is already running at or below the Federal Reserve’s 2% target, cheaper Chinese exports have a downward effect on U.S. import prices and make American goods less competitive on the global scale.
While China’s actions dragged down global markets in August, U.S. stocks stayed calm after the initial surprise on August 11th, with the S&P 500 up 0.3% and safe-haven investments like utilities and telecoms outperforming. The last six trading sessions leading into August 24th created memorable volatility with the Dow Jones Industrial Average falling over 1,000 points in a few minutes on Black Monday, August 24th. Yes, this rapid market deterioration is imported from China because the growth forecast has slowed to 6.8% from 7.4% in 2014. So really, what of it? Exports to China only make-up 0.7% of U.S. GDP. And, what’s an investor to do in the meanwhile? At times when growth isn’t perceived to be strong and rates are low, investors tend to turn to high-dividend yielding, or rate-sensitive, stocks to seek sure, less-risky means to income.
In China, combined the Shanghai and Shenzhen stock exchanges rank second in the world in market capitalization behind the New York Stock Exchange, and in the top 10 in terms of number of listed companies.
After increasing in value by about 150% from January 2014 to June 2015, the Chinese stock markets have tumbled by 30% recently. China’s two exchanges have lost $3.5 Trillion in value since the slide started in mid-June, or about 14x the current annual GDP of Greece.
There are essential differences between the Chinese and U.S. stock markets. Unlike the U.S. markets, where investors are mostly institutional, four out of five investors in the Chinese stock markets are small retail investors. Most of the Chinese investors who have lost money are late arrivals to investing and unsophisticated investors who have entered the stock market within the past year. Furthermore, the Chinese stock market, compared to that in the States is underdeveloped and controlled by its government, with the majority of its investors expecting the Chinese government to maintain its stability. Moreover, the majority of Chinese investments are leveraged and traded on margin - simply by using borrowed money to invest - which can be problematic and cause China’s stock market volatility as investors fail to meet their margin calls when there's a downturn. When the People's Bank of China announced a 1.9% devaluation of the Yuan reference rate, it caused more uncertainties.
Since the crash began, Chinese authorities and the People’s Bank of China have taken unleashed interventions to calm the panic selling, including restricting the short selling, cutting interest rates, reducing the bank reserve requirement ratio, suspending IPOs, implementing a RMB120billion fund to buy stocks, and suspending trading in a large percentage of publicly traded shares.
The crash in China’s stock markets sent a distress signal to global markets that something is going wrong in the Chinese economy, its GDP growth rate reduced from 14% in 2007 to 7.4% last year along with the GDP prediction expected to show slower growth. Indeed the GDP growth trend is moving downward, yet it’s still manageable.
China's stock markets are suffering from extreme volatility - so what does that mean for U.S. investors? It would not be surprising to see the U.S. markets continue to be stressed, however, the S&P 500 is only down by 6% from mid-June to late-August. With this in mind, the U.S. stock market may not pose the real danger for global equity investors.
The caution lights may begin flashing for the U.S. bond market which should be observed intently by all fixed income investors during the next few quarters, because the Chinese government is the largest owner of U.S. government bonds, owning $1.3 trillion. Combined with the Federal Reserve contemplating lift-off by raising the Fed Funds rate in September or December - the bond market may become highly volatile.
Mark Martiak is a Registered Representative with First Allied Securities Inc. Member FINRA/SIPC and a Senior Vice President of Premier Wealth Advisors. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed.