The round-the-clock financial news cycle likes to attribute every market move to some cause. Whether the reported reason is an economic report, an earnings release, a Fed announcement, or just rumors and speculation about these potential causes, the media continually seeks to answer the question of “why” the market moved the way it did.
Sometimes the purported catalyst strains the limits of credibility, and other times the reason sounds completely logical. This week, the Chinese Yuan is getting the blame for all of the negative market action. In case you haven’t heard, China’s central bank devalued its currency early Tuesday, a move that apparently caught the world off guard.
Although a 1.9% devaluation is rather small, the policy change was significant for many reasons. First of all, the Chinese government has loosely tied its currency to the US Dollar for a couple of decades. Just a few months ago, other central banks seemed confident that this relationship would not change, but change it did.
The US Dollar has risen strongly against other currencies the past few years. As a result of the Yuan’s loose peg to our currency, the Yuan has risen 30% against the Euro. This in turn has caused China’s exports to Europe to drop sharply as they became less competitive. Given the magnitude of the Yuan’s rise against the Euro, the relatively small 1.9% devaluation seems like small potatoes, so it is mostly the surprise factor that has investors worried.
Politically, the devaluation tends to hinder China’s desire to make the yuan an official IMF global reserve currency, an elite category composed of the US Dollar, Japanese Yen, Euro, and British Pound. The US, long believing that China’s currency has been undervalued, has consistently urged China to let market forces determine the value of the yuan. This gave China the political cover it needed for the devaluation, with China claiming it was going to let market forces help determine its currency’s valuation instead of the central government declaring a daily fix within a 2% trading band.
However, the Chinese government has already blown its cover. Earlier today, China’s central bank intervened in world currency markets to prop up the Yuan. In less than 36 hours, the People’s Bank of China went from pledging to let market forces play a bigger in establishing the Yuan’s value to staging a currency intervention. Call it hypocrisy, or call it a communist government’s inability to relinquish control, the net result is still the same – China has taken a step backward on the global stage.
Consumer Staples jumped two spots higher to claim the top sector ranking. The last time Consumer Staples took the top honors was on March 27, 2013. In case you are wondering what happened next, the Consumer Staples benchmark was 6% higher seven weeks later, up 12% by the end of the year, and yesterday closed 36% above its level of 124 weeks ago. Financials climbed two spots to land in second, while Utilities jumped three places to grab third. The big changes at the top do not stop there. Consumer Discretionary and Health Care, the former #1 and #2 sectors, respectively, were both pushed three spots lower, and Real Estate fell one notch to sixth. The good news is that these top six sectors managed to hold on to their positive momentum scores this week. Recent market action suggests their ability to make that claim again next week is not guaranteed. Telecom and Technology swapped places as Industrials, Materials, and Energy trail behind. Materials and Energy are both deep in the red, and Energy is actually showing some signs of stabilization despite crude oil prices dropping to a six-year low.
The quantity of style categories with positive momentum dropped from five to one this week. Large-Cap Growth sits at the top for a second week and is the lone category still in the green. However, it is barely clinging to that status and will easily succumb to the downside if market action doesn’t improve in the next few days. The four categories flipping over to red this week are Mega-Cap, Large-Cap Blend, Mid-Cap Growth, and Small-Cap Growth. Small-Cap Growth suffered the largest setback of any style category with its plunge from third to eighth in the rankings. The drop of Small-Cap Growth allowed five other categories to move higher and placed the four smallest capitalization segments together on the bottom. Micro-Cap slipped below Small-Cap Value to reside on the bottom, completing its six-week trip from first place to last.
The Eurozone extended its time at the top to four consecutive weeks, which is no small feat given the uncertainty about the situation in Greece. Japan remains solidly in second and EAFE moved up a notch to third. All three of these global categories were able to improve their momentum score amid generally shaky market conditions. The UK moved a step higher, but its momentum has not turned positive. The US slipped two spots lower and lost its last sliver of positive bias. World Equity held steady in sixth and creates a line of demarcation with the five lower categories all in steep downtrends. The bottom five consist of the three developing market categories, Canada, and Pacific ex-Japan. Richness of natural resources is the commonality between Canada and Pacific ex-Japan, and those resources are currently in a high supply/low demand situation, putting pressure on stock prices. China and Latin America have been jockeying back and forth for last place, and this week Latin America finds itself on the bottom.
“With all the efforts to make the economy more market-oriented, the government is introducing more risks into its financial system, but whenever it starts to intervene again, it puts its credibility on the line.”
– Zhu Chaoping, China economist at UOB Kay Hian Holdings Ltd., a Singapore-based investment bank.
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