Monday’s (August 5th) sell off had many iterating the legendary coach, Vince Lombardi’s words: “What the hell is going on out here?”.
Traders worry spiked to fear that the situation with China could turn from a currency/trade war into a currency crisis (meaning Chinese panic pulling their money out of China) which would cause a plunging Yuan/Renminbi. Why are traders so afraid of this?
A currency crisis could ignite a new global recession – this is why the mood turned ugly when the Yuan started plunging. Fear gripped traders as they wondered if China was letting their currency drop as a warning sign to the US or worse was it plunging because of the beginning of a flight of capital (Chinese dumping their own currency for another) for which the government in Beijing could not control.
Let me clarify this a bit further. First, it is normal and expected when tariffs are put on a country that it’s currency will drop in value as compared to the country that instituted the tariffs. So as the US has raised tariffs it is normal that China’s currency would decline against the US dollar. If the currency starts declining rapidly sometimes people panic and rush to pull all of their money out and convert it into another currency they view as safer (currency crisis). We’ve seen this numerous times just in the past 20 years around the globe. The plunging currency causes fear and the fear causes the currency to plunge more. It can cause serious damage to an economy. Is this the plan of the US administration? An offsetting move for the US to counter the rising dollar against the Yuan would be to lower US interest rates. Sounds like the current environment.
Markets dislike a currency fight between the world’s two largest economies but they dread a currency crisis with either of them.
This morning people are feeling better as China stepped in to stabilize its currency: first because they did step in and secondly because their efforts still can prop up the currency are giving many comfort. Since 2011, I’ve talked about my fear of China’s monstrous debt in my Market Updates, you know my biggest worry has been and remains China’s monstrous debt. Make no mistake, the current fight between the US and China is hurting China’s economy especially because many of the world’s other economies China’s are stagnant or declining. At this point China continues to show they will incur more economic pain. At what point does the economy slow down enough that its debt monster cannot be contained? This is THE question that I’m not aware anyone knows. August 5th may turn out to be a first crack in China’s containment of the monster.
Long term investing themes such as aerospace/defense, cyber-security, water, consumer staples, 5G buildout continue to show growth. The current sell-off seems to me to be just another profit taking with earnings season mostly over, enhanced by fear (emotion) which could birth yet another buying opportunity into areas of continued growth UNLESS the situation with China turns from a currency/trade war into a currency crisis. The US China meetings scheduled for September need to show some reverse from the current escalation otherwise my fear of China’s debt monster escaping will rise. IF others share in that fear to the point that Chinese citizens start fleeing their own currency then a real (significant) sell off could ensue. There are a lot of worries in the markets, there always seem to be. Throughout the current, long bull market there have been lots of sell offs (please read “Snap Out of It” update). But to me, China’s currency and thus China’s debt is THE key metric to watch for a reversal to the bull market – everything else is a distraction to “fundamentals” investing.
As your investment adviser, I’m daily assessing the data available and measuring risk vs reward potential. Should we see the currency situation worsen, I expect to increase cash levels in accounts, otherwise I continue to refine my shopping list for putting cash in accounts back to work as this sell off levels out. Please call me at your convenience to discuss your portfolio or situation or should you have questions.
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