China rattled global equities on Tuesday, August 11 when they devalued the yuan against the dollar nearly 2%; the largest devaluation since China implemented its ‘modern’ exchange rate system in 1994. The S&P 500 immediately sank -1.5% at the start of trading on Wednesday (August 12), and European markets finished the day down -2.7%.

China – Distraction or Problem? 

Let me start by saying that I won’t attempt to sugarcoat China’s slowing growth and market volatility.

The Shanghai and Shenzhen stock markets endured steep bear markets through June and July, and bits of China’s economic data has been weak – July exports tumbled -8.3% from a year ago (the weakest reading since February 2014) coming in well below expectations. That brought exports for the year down almost 1% compared with the same period last year. Not encouraging news for investors.

Then, this week, we experienced another more notable downturn. Again, likely tied to concerns over a weakening China; the second largest economy. But, if you consider these issues in context, I think it should temper concerns. For one, we’ve known for some time that China wants to rely less on exports and state spending and more on services and domestic consumption. So, weakening numbers in the manufacturing and export sectors shouldn’t be a big surprise. In fact, they’re to be expected.

Second, the Chinese stock market isn’t a good indicator or influencer for global markets – China’s Shanghai and Shenzhen markets are largely closed off to foreign investors, and its ‘A-shares’ have already endured two bear markets since 2009 (while global stocks have for the most part steadily climbed).

The China devaluation story, in my view, is simply an easy media target. It comes timed along with concerns over growth and headlines on Chinese stock market volatility. The reality is that a 2% devaluation hasn’t changed China’s or the global economy’s trajectory.

Two Unappreciated Features of China’s Currency Devaluation

1. The Market Called for a Devaluation – With the dollar’s strength, China’s slowing growth and capital outflows, and recent interest rate cuts from the People’s Bank of China, the yuan has been strengthening considerably over the past year. The nominal effective exchange rate has risen by 13.5% against the dollar since June 2014, and the yuan has also appreciated by 23% and 17% against the euro and the yen in the past year, respectively. The effects have been mixed: China’s exports to the European Union and Japan have declined by 4% and 11% year-on-year, but have increased by 7% to the U.S. If China had effectively decided last Tuesday to let their currency float, it would have depreciated anyway. Letting it fall 2% was hardly a big deal.

2. The Currency Devaluation Could be a Good Thing – To the extent that China is actually intent on allowing the market to set exchange rates, the devaluation could be a positive development. The U.S. stopped short of criticizing the move for that reason, and the International Monetary Fund called the devaluation a “welcome step,” noting that “greater exchange rate flexibility is important for China as it strives to give market forces a decisive role in the economy [while] rapidly integrating into global financial markets.” We shall see. On an economic note, a weaker yuan could help lift exports to Europe and Japan, both of which are expected to grow modestly this year.

Bottom Line for Investors

The big “wait and see” here is evaluating to what degree China allows market forces to set the exchange rate moving forward. Allowing their currency to depreciate at a time when exports are slumping and economic growth is middling seems awfully convenient to serving the state’s interests. Whether it also means allowing the yuan to strengthen when the market calls for it remains to be seen. U.S. manufacturers aren’t holding their breath, but time will tell.

In the medium term, the currency devaluation is likely to be a low impact story. However, in the short term, volatility is likely to continue so I caution investors to keep emotions in check. If anything, the stock market response may give us further indication that investors flock to U.S. stocks in times of uncertainty – more reason to overweight domestic equities in the late stages of a bull.

– Mitch


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Zacks Investment Management, Inc. is a wholly-owned subsidiary of Zacks Investment Research. Zacks Investment Management is an independent Registered Investment Advisory firm and acts an investment manager for individuals and institutions. Zacks Investment Research is a provider of earnings data and other financial data to institutions and to individuals.

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