Well the selloff in China is not a good way to start out the year. The U.S. and other global stock markets all have sold off to start the year due to the fears regarding the Chinese market after circuit breakers were triggered and trading halted today. Keep in mind that this is very similar to the global selloff that happened in August 2015 that was also the result of China’s currency devaluation. We are watching this situation closely and we are confident that the global markets will rebound as buyers step in to take advantage of this short term selloff. U.S. earnings have started to come out for the fourth Quarter and they look very good thus far. Recent U.S. and European economic data has also shown positive signs that indicate better growth rates are possible in 2016. Low energy costs, cheap cost of capital, low labor rates and raw material costs are all helping companies produce earnings growth which should support equity markets in 2016. We will have our 2016 Market Outlook sent out to you early next week which gives a comprehensive review of the major issues that will impact the markets this year.
The volatility in the Chinese stock market was triggered by the news that China allowed the biggest fall in the yuan in five months. China’s devaluation of its currency is aimed at providing a competitive devaluation to help its exporters who have seen a decline in orders the last few quarters. China’s stock markets were suspended for the day less than half an hour after the open as a new circuit-breaking mechanism that halts trading if the Chinese stock market falls 7% was triggered for the second time this week. The People’s Bank of China (PBOC) surprised markets by setting the official midpoint rate on the yuan, also known as the renminbi (RMB), 0.5 percent weaker at 6.5646 per dollar, the lowest since March 2011. This was the biggest daily fall in their currency since last August, when a two percent devaluation of their currency also roiled markets. However, back in August the PBOC intervened in the offshore currency markets to reverse a more than 1 percent fall in offshore rates for the yuan after they hit a record low of 6.7600 per dollar. The current situation is likely going to be very similar to the currency devaluation China made in August 2015 where they weaken the official rate and then intervene against the dollar offshore to beat back the speculators. We expect China to intervene in a similar way to stabilize the market. The fear that investors have is that China’s currency devaluation is a “zero sum game” as other currencies weakened in response, and the end result could be price deflation and greater volatility.
The currency devaluation decision by China was in response to the latest manufacturing survey which fell to 48.2 in December following two months of stabilization. There are additional factors that are impacting the selloff in China – the scheduled lifting of bans on IPOs and stock sales by larger investors.
China’s rapid economic ascent over the last few decades has been boosted by its low cost manufacturing base. China has led the world in technology manufacturing for decades – for instance most of Apple’s products are made in China. But a slowdown in manufacturing has been happening over the past few years, but that is not a surprise. China has been trying to transform itself from a manufacturing economy to an internal consumption economy (like the U.S.). The problem is consumer and business consumption in China has not been high enough yet to make up for the reduction in manufacturing.
China has to also transition from a Government controlled economy to an economy based on market forces. They need to let the market determine which companies are better managed and the Government should continue to step back from intervening in Chinese businesses. China has been liberalizing some of its financial and economic policies, and that has led to a significant increase in consumer spending. But this growing leisure class is still largely limited to an elite, wealthy class and hasn’t really proliferated to larger swaths of the population. Over the next decade we should see a “middle class” develop in China. In order for this to happen the Chinese government is going to have to step back from trying to manage both large and small aspects of the economy. China in the past has benefited from the strength of a market-based economy while not losing any of its central control. But this type of “pseudo capitalism” is what is creating this high volatility in the Chinese stock market. Individual investors comprise 80% of the Chinese stock market trading and therefore larger swings are experienced because they tend to be more short term oriented. As the Chinese government continues to allow market forces to play a bigger role institutional investors will invest more money in Chinese stocks and help reduce volatility.
One of our other concerns with the selloff in China is that it will hurt consumer and business confidence. Consumer and Business confidence in the U.S. and Global economy has a big impact on spending. If the world “feels” less safe (as it has since 2008) big decisions on buying a new house or making a strategic business acquisition or building a new office are put on hold. This has been the case for many years and our research at the end of 2015 indicated that confidence was improving and that consumers and businesses were going to come out of “bunker” mode in 2016. Starting the year with the Chinese selloff does not help build confidence. However, if we see things stabilize short term in China and at the same time U.S. and European economic data comes in better than expected we should see the Global markets get back on track to produce good returns in 2016.
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