Whoa. What happened in China?
In a nutshell, China’s economy is slowing. So, to stimulate exports, China devalued its currency by about 3%. (For more nuance, read any of the excellent plain English explainers by Business Insider’s Mike Bird, Greg McKenna, and Linette Lopez. Or read all three!)
For the longest time, companies with footholds in China happily boasted about all of the growth that they were generating from the developing economy.
And now that there are growing signs of problems, everyone from economists to investment strategists to corporate executives are doing damage control, downplaying their exposures while talking up the more stable side of things.
Bottom line: China is the second largest economy in the world. And what happens there matters.
Here’s your Monday Scouting Report:
China doesn’t matter to the US … yet. China is a big trading partner with the US. But it also isn’t its only trading partner. Wells Fargo’s Jay Bryson writes: “The direct economic and financial exposure of the United States to China is rather limited. China accounts for only 7% of total America exports, which represents less than 1% of US GDP, and American multinational enterprises (MNEs) derive only 2% of their net income from China. American banking exposure to China represents less than 1% of banking system assets. Even when indirect effects, which operate through the exposure of other countries to China, are considered, it appears that total American exposure to China is rather limited.”
In theory, a weaker renminbi should boost US imports from China while hurting US exports to China. However, UBS’s Sam Coffin notes that this type of distortion did not occur in the recent past when the renminbi weakened. From Coffin’s note: “Perhaps less appreciated, US exports to and imports from China are remarkably insensitive to exchange rates. These exports and imports move in tandem — more a function of growth than price (exchange rates). Slower Chinese growth is a risk to US exports, but that risk is lessened by the Renminbi devaluation.”
- … but there’s also the bearish take. Societe Generale’s Albert Edwards has been bearish about most things for a very long time. But while his bearish stock market calls have yet to pan out, his forecasts for falling interest rates and warnings about low inflation and deflation have at least been on the right side. Regarding China’s currency devaluation, Edwards warns this is is the country exporting deflation. From his note this week: “We expect the acceleration of EM devaluations to send waves of deflation to the west to overwhelm already struggling corporate profitability and take us back into outright recession. As investors realise yet another recession beckons, without any normalization of either interest rates or fiscal imbalances in this cycle, expect a financial market rout every bit as large as 2008.” Yikes.
The uncertainty of it all. Perhaps the most important revelation from China’s shift in FX policy was the fact that it caught everyone by surprise. Uncertainty is a very scary thing for investors and traders, who will demand a premium for the risk they take when the outlook becomes more unclear. Here’s SocGen economist Michala Marcussen: “China has been centre stage on financial markets over much of the summer; a few weeks ago it was the equity market and last Tuesday came a surprise shift in the FX policy. While the latter may well have been motivated by the IMF, what is striking is the increased sense of market uncertainty, both as to what’s really going on in the Chinese economy and as to how well armed policymakers are to tackle the issues. While we were surprised by the timing of the CNY move, greater Chinese policy uncertainty sits at the core of our long held bumpy landing scenario.“
AP ImagesZhou Xiaochuan, governor of the People’s Bank of China
Brean Capital’s Peter Tchir pondered all this last week. From his note: “As the “Currency War” officially kicks off, I can’t help but think back to Donald Rumsfeld’s famous quote about Known Knowns, Known Unknowns, and Unknown Unknowns. We definitively KNOW that China has embarked on an aggressive policy of devaluation … What is UNKNOWN, at least to me is the ultimate impact of this and what it reveals … I do KNOW that we have added a new, large and unexpected variable to the global economic and markets. In such a COMPLEX system that is likely to have unintended and unexpected consequences that are far from obvious, which makes me want to remain cautious on the risk taking side.”
- Empire Manufacturing (Mon): Economists estimate this regional manufacturing index improved to 4.5 in August from 3.86 in July. From UBS’s Kevin Cummins: “The current activity index in the Empire State manufacturing index has been running weaker than the national ISM for some time. Details of the survey have appeared no stronger: our ISM-equivalent measure, which combines details of the survey in the same fashion as the manufacturing ISM, was below the break-even 50 level in July. We project some catch-up in August. The one positive element in the July NY Fed survey was a rebound in capex expectations.”
- NAHB Housing Market Index (Mon): Economists estimate this measure of homebuilder sentiment climbed to 61 in August from 60 in July. From Nomura: “The NAHB housing market index is near pre- recession levels, but housing starts remain depressed relative to historical standards, suggesting that there is still room for growth in the housing sector. Optimistic homebuilder sentiment, coupled with improving household fundamentals, could support a sustained rebound in the housing market in the medium term. Mortgage applications for purchases index declined in the first week of August, but residential construction employment rose last month.”
- Housing Starts (Tues): Economists estimate the pace of starts climbed 1.0% to an annualized rate of 1.186 million units. Building permits are estimated to have dropped 8.0% to 1.23 million. From Wells Fargo’s Sam Bullard: “On balance, housing market activity has been on an upward trend in recent months. In Q2, total housing starts averaged a 1.14million unit annualized pace, the strongest quarterly pace in almost eight years. On continued improvement in the labour market, elevated homebuilder confidence, easing bank lending standards and low interest rates, we expect housing demand to remain solid in the second half of the year. After a multifamilyled 9.8% gain in June, we expect housing starts rose 2.2% in July to a 1.20million unit annualized pace as gains in single family more than offset an anticipated decline in multifamily. Building permits are likely to pull back substantially, primarily in multifamily, reflecting the expiration of New York City tax incentives which pulled permits forward in June.”
- Consumer Price Index (Wed): Economists estimate prices climbed 0.2% month-over-month in July or 0.2% year-over-year. Excluding food and energy, core CPI is estimated to have increased by 0.2% and 1.8%, respectively. From Credit Suisse: “A continuation of monthly retail inflation readings similar to those expected for July would be a welcomed outcome, as the main concern today is inflation that is too slow, not too fast. However, the continued plunge in global commodity prices and more upward pressure on the foreign exchange value of the dollar following China’s currency devaluation threaten to slow inflation in the near term. Whether this challenges the Fed’s reasonable confidence “that inflation will move back to its 2 per cent objective over the medium term” remains to be seen.”
- FOMC Minutes (Wed): At 2:00 p.m. ET, the Federal Reserve will publish the minutes from its July 28029 Federal Open Market Committee meeting. From Credit Suisse: “We imagine that the FOMC majority in July was hoping to have the opportunity to nudge up its funds rate target range by 25bp in September. But the outlook was far too cloudy three weeks ago to promise such a move. (China’s devaluation of the yuan this week has further obscured the outlook.) The risk is that the minutes will do little to increase the Street’s conviction on the timing of the first rate hike, and we will be back to monitoring global financial conditions and high-frequency domestic data releases.”
- Initial Jobless Claims (Thurs): Economists estimate initial claims slipped to 272,000 from 274,000 a week ago. From Well’s Fargo’s Joe LaVorgna: “Thursday’s initial jobless claims data take on added significance since they cover the August employment survey period. While the claims numbers are expected to remain near a four-decade low, August nonfarm payrolls could disappoint given their historical tendency to do so.”
- Existing Home Sales Sales (Thurs): Economists estimate the pace of sales fell 1.2% in July to an annualized rate of 5.43 million units. From Wells Fargo’s Bullard: “Increasing for the second straight month and standing at an eightyear high, existing home sales rose 3.2% in June to a 5.49million unit annualized pace. Improvement was broad based across the country with singlefamily home sales rising 2.8% and condo/coop sales jumping 6.6% on the month. A modest pullback appears to be in store in July given the recent forwardlooking pending home sales index performance. After increasing for five straight months, the pending home sales index fell 1.8% in June. Pending home sales, based on signings of sales contracts, tend to lead existing home sales by 12 months.”
- Philadelphia Fed Business Outlook (Thurs): Economists estimate this activity index improved to 7.0 in August from 5.7 in July. From UBS’s Sam Coffin: “Details of the Philadelphia Fed survey were even softer than the headline index in July. The headline index, which is based on a single, stand-alone question about general business conditions, fell to 5.7 from 15.2; however, our ISM-equivalent series, which aggregates other details of the survey, fell almost to its 50 break-even level. We project re-acceleration in August, as the national ISM index has not appeared as weak.”
- Markit US Manufacturing PMI (Fri): Economists estimate this manufacturing index was unchanged at 53.8 in August.
The slow of China’s massive economy and the devaluing of its currency is a big concern for US investors. Obviously, the companies with greater exposure to China are going to feel greater pressure.
Taking a closer look at the internals of the market, Citi’s Tobias Levkovich argued that measures of volatility and sentiment favoured the forward-thinking investor.
“It is preferable to look at 90-day implied volatility relative to the 30-day VIX for statistical signals,” Levkovich wrote in a note to clients on Wednesday. “[The historical data signals] a near 94% chance for a higher market (with median and mean double-digit appreciation) a year later, well above the 81% random outcome. In this respect, the data seems to support other indications of upside potential including 90% probability from our Panic/Euphoria Model , which while not in panic territory is still generating a positive indication.”
Veteran strategist Rich Bernstein also thinks negative sentiment is a reason to be long stocks.
“The US bull market is more than six years old, but investors haven’t yet embraced it,”Bernstein writes. “Recent mutual fund flow data continue to show that investors are habitually selling US equity funds, but buying non-US equity funds. Anyone with the smallest contrarian streak must be fascinated by these trends.”
For Warren Buffett, it’s all about the long run.
“Stocks are going to be higher,” Buffett told CNBC’s last week. Specifically, he said he expected prices to be “a lot higher” 10 years or 20 years from now.
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