The equity markets tanked on Monday after China devalued its currency, the Renminbi (sometimes called the Yuan), to its lowest level in over a decade. That was in retaliation for President Trump raising tariffs by 10% on $300 billion in goods. The latter was insignificant as it only amounts to a maximum of $30 billion in additional costs spread out over a significantly larger economy. The former was more telling.
To begin with, as I have mentioned in the past and President Trump has railed on, China is a currency manipulator. More on that later. However, China’s devaluation showed that nation’s cards. In a game of poker, it is bad enough to have a “tell” which is a change in behavior that tips off opponents as to what a player is thinking. That is one thing, but when you show your hand to an opponent, that is plain stupid. China was plain stupid. Let me explain.
China’s currency is controlled by the Chinese government, rather than free float as pretty much most major currencies are traded. Some currencies are pegged to other currencies like the US Dollar (USD) and some are pegged to a basket of currencies. China’s is fixed by its centrally managed government.
In devaluating its currency, China has increased purchasing power by other nations, such as the USA. In other words, we can buy more Chinese goods with less USD. What it also tells me, and many other economists is that China needs USD. China’s reserves of USD have been lent out to its nation’s banks, which are essentially arms of the Chinese government. Those USD were lent out to Chinese businesses to purchase US goods or more importantly make investments in the USA. It cannot be taken back. All that China has left is about $1.1 trillion of US Treasury debt that it can liquidate. Of course, if it tries to, the markets will see it coming and lower the price of US Treasuries. In turn the yield curve would steepen, which would be welcomed by the markets.
The Chinese economy is faltering. The reported GDP growth of 6.2% is the lowest in nearly three decades. However, no sane economist or investor believes that growth figure. Furthermore, the trajectory of the Chinese economy is downward. The devaluation will give an instant boost to GDP by taking in more Renminbi for the same amount of foreign currency sales. Recall that China did so in the summer of 2015 which sparked another short-lived market panic.
That is not all of China’s problems. The nation’s economic and banking center, Hong Kong is the midst of massive demonstrations, greater than that of the Tiananmen Square protests of 1989. The Hong Kong protests are in opposition to a controversial extradition law. That law would permit the transfer of criminal suspects directly to the mainland. China’s Renminbi move, in my opinion, is in part an attempt to divert attention away from the goings on in Hong Kong.
After the markets closed, the US Treasury finally declared that China is a currency manipulator. Now Secretary of the Treasury Steven Mnuchin will take that the case to the International Monetary Fund (IMF).
China has now gone all in. However, we see their cards. China will be forced to make a trade deal with the US on less favorable terms to the Middle Kingdom than may have been available before. In the fullness of time, President Trump’s defense of the US economy will be successful; just the means to the end might produce some agita.
As of today’s market close, US stock indexes are about 6% off their highs reached last month. Recall that I was calling for a pullback of 5 – 10%. The pullback all began after Fed Chair Jerome Powell cut rates by ¼%. However, he still has not learned the art of communication and the markets began to sell down a bit faster. The correction should have taken place over a few weeks. However, the China nonsense is just making it happen more rapidly. After the Treasury announcement, stock futures took another leg lower, about 1.00%. This rapid selloff will have three important reactions.
First, are downgrades from the buyside analysts who act in unison and without much rigor. Second, is increased panics by retail investors who will be selling their mutual funds without regard to price, like irrational lemmings. Third, professionals who though on vacation remain opportunistic and will be phoning in to their subordinates telling them to cover shorts and scale into purchases.
Thus, expect a lower open into which you can cover hedges and nibble a bit on stocks. I will be doing just that. Let me feed you a little taste – I will be buying Cisco (CSCO) for our Growth portfolio accounts, which is already a long term holding in out Dividend Value portfolio accounts. CSCO is a safe way to dip a toe back into the water for at least a rebound trade.
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Disclosure: At the time of this commentary Scott Rothbort, his family and/or clients of LakeView AssetManagement, LLC was long CSCO – although positions can change at any time.
Scott Rothbort is the President & Founder of LakeView Asset Management, LLC, a registered investment advisor specializing in high net worth private wealth management. For more information on investing with LakeView Asset Management, LLC call us at 888-9LAKEVIEW or request more information by clicking on the contact button on the top right-hand corner of the website. LakeView Management, LLC is a Nevada LLC, with its principal office located in Henderson, NV and branch office located in Millburn, NJ
Scott Rothbort is also the publisher of the LakeView Restaurant & Food Chain Report, a newsletter focusing in on food, restaurant, beverage, and agricultural stocks. An individual subscription to the newsletter can be ordered at www.restaurantstox.com Furthermore; Scott is a professor at the Seton Hall Stillman School of Business in South Orange, NJ.
– You can email Scott at scott.rothbort.lakeview@gmail.com
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Miss your commentary on RMP on days like today