A slowing Chinese economy coupled with a surprise devaluation of the Chinese currency (seen as confirmation of Chinese problems) has scared the bejesus out of investors. The fear is that China, the world’s second largest economy, will stall economic growth across the globe. For some countries, it’s true.
Recent US stock market volatility can be traced to extreme volatility in China. After a parabolic rise early this year, Chinese stocks fueled by margin buying (borrowing) have had an equally breath taking decline. The Chinese government, despite ham handed attempts to intervene by both buying stocks and issuing new regulations, has failed to arrest the decline. Institutional investors in China are being subtly and not so subtly threatened regarding their stock trading activities. The message: If the government can’t arrest the decline they might arrest its ‘perpetrators’.
Figure 1
Shanghai Composite Index: 2010-2015
Source: Bloomberg
The stock prices of US companies with significant foreign sales are have suffered from a stronger US dollar (resulting in lower sales /profits from abroad) and slower global economic growth. Considering the turmoil, the US stock market’s reaction is to be expected.
Bonds prices have increased (yields have declined from June-July peaks) as global investors have sought a safe haven. Bonds do well in a faltering economic environment. Frustratingly, I was just starting to find some good buys during those peak interest rates and now rates are lower.
Figure 2
10 Year US Treasury Rates 2015
Source: Yahoo Finance
US Economy Still on Track
Meanwhile the US economy looks pretty good. Good enough for the Fed to consider raising the Fed Funds interest rate from zero to .25% in September. I will not bore you all with comments surrounding the possible rate hike. Most likely it will be in either mid-September or December. I believe that a Fed rate hike will have some negative consequences for stock prices, but those would be short lived. An increase in longer-term interest rates as depicted by the 10 Year US Treasury would be more negative for stocks. A meaningful increase in long term interest rates is less likely as long as global growth is waning.
I have been writing about a return of stock market volatility for several quarters. As I mentioned in a previous newsletter, in a low return environment you must have the patience to wait for something to break. This is the reason for having cash on hand. Please let me know if you have any questions or concerns!