Market Update: March 6, 2017

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  • Equities move lower to begin week. U.S. stocks are moving lower in early trading, following their European counterparts on little news. The major averages all managed to squeak out slight gains on Friday; the S&P 500’s 0.1% gain was led by financials and healthcare, which both closed up 0.4%. Overnight in Asia, stocks finished mostly higher with the exception of Japan’s Nikkei (-0.5%) as the yen strengthened; the STOXX Europe 600 is lower by 0.5% in afternoon trading. Meanwhile, the yield on the 10-year Treasury is near flat at 2.48% as market-implied expectations of a Fed rate hike in March are near 86%, WTI crude oil ($53.25/barrel) is slightly lower, and COMEX gold ($1231/oz.) is climbing 0.4%.

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  • Brexit, EU summit, China forecasts, Fed “quiet period”, and February jobs report highlight week ahead. Other than the February employment report (due out this Friday, March 10)  it’s a relatively quiet week for U.S. economic data. It’s also the unofficial quiet period for the Federal Reserve ahead of the March 14-15 FOMC meeting. The overseas calendar is chock full of potentially market-moving events, including the EU leaders summit, a potential House of Lords vote on Brexit, the European Central Bank meeting, and a few key reports on China’s economy in February.
  • Beige Book. This week, we’ll examine the Fed’s latest Beige Book, looking for signs of any impact from the new Trump administration, an overheating labor market, rising wages, and inflation ahead of next week’s FOMC meeting.
  • Corporate sentiment improved again in our latest Corporate Beige Book. Sentiment improved among corporate executives based on our analysis of fourth quarter earnings conference call transcripts. Not surprisingly, policy was a popular topic, as corporate tax reform, infrastructure and regulation saw big jumps in the number of mentions. Currency and China also continued to garner a lot of attention, while energy and Brexit faded. The solid fourth quarter results coupled with improved sentiment from corporate executives support our expectation of mid-to-high single digit earnings growth for the S&P 500 in 2017.
  • The Chinese National People’s Congress began its annual meeting on Sunday. Nothing shocking has come out of the meeting so far, though little was expected. Official economic growth forecasts have been cut to 6.5%. The focus of the meeting has been on economic stability, including a reduction in monetary growth targets and efforts to reduce China’s bad debt problem. The most notable change in language related to calls for further currency liberalization. A more market-oriented currency policy suggests potential weakening of the yuan, which would run counter to China’s long-term political goals, as well as increase the likelihood of China being labeled a “currency manipulator” by the Trump administration.
  • Make that six in a row. The S&P 500 was up 0.7% for the second consecutive week, and managed to close at a new weekly all-time high. In the process, it closed higher for the sixth consecutive week for the first time since a six-week win streak off of the February 2016 lows. The last time it was up seven weeks in a row was late 2014. Here’s the catch, the S&P 500 was up only 4.9% the past six weeks – making this one of the weakest six-week win streaks ever. Given the historically small daily trading ranges recently, this shouldn’t come as a big surprise. You have to go back to late 2013 for the last time there was a smaller return during a six-week win streak.

MonitoringWeek_header

Monday

  • Kashkari (Dove)

 Tuesday

  • China: Imports and Exports (Feb)
  • Japan: Economy Watchers Survey

 Wednesday

  • ADP Employment (Feb)
  • China: CPI (Feb)

Thursday

  • Initial Claims (3/5)
  • Challenger Job Cut Announcements (Feb)
  • Household Net Worth and Flow of Funds (Q4)
  • European Union leaders Summit in Brussels Begins
  • Eurozone: European Central Bank Meeting (No Change Expected)

Friday

  • Employment Report (Feb)
  • European Union leaders Summit in Brussels Continues

 

 

 

 

 

Important Disclosures: Past performance is no guarantee of future results. The economic forecasts set forth in the presentation may not develop as predicted. The opinions voiced in this material are for general information only and are not intended to provide or be construed as providing specific investment advice or recommendations for any individual security. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly. Stock investing involves risk including loss of principal. Investing in foreign and emerging markets securities involves special additional risks. These risks include, but are not limited to, currency risk, political risk, and risk associated with varying accounting standards. Investing in emerging markets may accentuate these risks. Treasury Inflation-Protected Securities (TIPS) are subject to interest rate risk and opportunity risk. If interest rates rise, the value of your bond on the secondary market will likely fall. In periods of no or low inflation, other investments, including other Treasury bonds, may perform better. Bank loans are loans issued by below investment-grade companies for short-term funding purposes with higher yield than short-term debt and involve risk. Because of its narrow focus, sector investing will be subject to greater volatility than investing more broadly across many sectors and companies. Commodity-linked investments may be more volatile and less liquid than the underlying instruments or measures, and their value may be affected by the performance of the overall commodities baskets as well as weather, disease, and regulatory developments. Government bonds and Treasury bills are guaranteed by the U.S. government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value. However, the value of fund shares is not guaranteed and will fluctuate. Investing in foreign and emerging markets debt securities involves special additional risks. These risks include, but are not limited to, currency risk, geopolitical and regulatory risk, and risk associated with varying settlement standards. High-yield/junk bonds are not investment-grade securities, involve substantial risks, and generally should be part of the diversified portfolio of sophisticated investors. Municipal bonds are subject to availability, price, and to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rate rise. Interest income may be subject to the alternative minimum tax. Federally tax-free but other state and local taxes may apply. Investing in real estate/REITs involves special risks such as potential illiquidity and may not be suitable for all investors. There is no assurance that the investment objectives of this program will be attained. Currency risk is a form of risk that arises from the change in price of one currency against another. Whenever investors or companies have assets or business operations across national borders, they face currency risk if their positions are not hedged. This research material has been prepared by LPL Financial LLC.

Market Update: February 6, 2017

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  • Stocks tick lower to begin quiet week. The S&P 500 is modestly lower in early trading, kicking off a week with little upcoming in the way of economic data and policy; earnings will likely take center stage. The S&P logged a 0.7% gain on Friday following the monthly jobs report, though stocks ended last week little changed despite a barrage of bellwether earnings reports. The S&P climbed 0.1% on the week on the back of a 2.4% gain in the healthcare sector. Asian indexes closed mostly higher overnight; the Hang Seng (+1.0%) outperformed the broader region despite a weak Caixin Services PMI report. European stocks are mostly lower in afternoon trading; Italy’s MIB (-1.6%) leads the way lower while the STOXX Europe 600 is down 0.4%. Finally, the yield on the 10-year Treasury note is down to 2.44%, WTI crude oil ($53.65/barrel) is lower by 0.3%, and COMEX gold ($1228/oz.) is rising 0.6%.

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  • Earnings pace picked up over the past week. S&P 500 estimates for the fourth quarter jumped 1.2% over the past week and are now tracking to an 8% year-over-year increase, 1.8% above initial estimates on January 1, 2017 (Thomson Reuters estimates). The latest improvement was driven largely by the energy sector, which had gotten off to a difficult start and now may produce its first earnings gain in more than two years. Financials and technology, the fastest earnings growers for the quarter, also saw earnings tick up over the past week. Guidance has been relatively good as 2017 S&P 500 estimates have fallen just 0.7% during earnings season, better than average (they typically drop 2-3%) and a positive sign, although only about 55% of S&P 500 companies have reported thus far. This week is another busy one for earnings with 89 S&P 500 companies slated to report.

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  •  Weekly gains again. After a 0.7% jump on Friday, the S&P 500 managed to squeak out a 0.1% gain for the week – the first back-to-back weekly win since Thanksgiving. The S&P 500 just missed out on a new all-time closing high Friday, but it did set a new weekly all-time high. Continuing a recent trend, equity prices gapped at the open, then did very little the rest of the day. In fact, the S&P 500 has now gone 34 consecutive days without a 1% daily range – tying the all-time record from 1995. It has now been 79 consecutive days without a 1% close lower for the S&P 500, the longest stretch in more than 20 years.
  • China continues its post-holiday bad news drip. More Caixin (mid-sized and smaller companies) data were released overnight. Composite PMI (both services and manufacturing) were down as manufacturing disappointed last week, while services fell this week to 53.1 from 53.4 in the prior month. However, the numbers still suggest expansion in the economy, just at a slower pace. This is the eleventh consecutive month of expansion. Asian markets (save Australia) had a positive session overnight and the Chinese yuan strengthened slightly.
  • European data shows continued expansion. European data released this morning show economic expansion, though not all numbers were rosy. German factory orders grew at 5.2% for the month, much better than expected. Retail PMIs also showed expansion (above 50) for most, but these numbers were weaker than expected in Germany and region wide. Of the major countries in Europe, Italy remains the weak link, with retail PMI below 50 since the end of 2015 and weaker than expected this month. Markets are weaker across the board this morning in Europe.
  • Quiet week ahead. Last week (January 30-February 3) was an unusually busy one for economic data and policy. This week (February 6-10) is not. While China will begin to report its January 2017 data set, there are few if any potentially market moving data reports on tap in the U.S., Europe, or Japan. There are a handful of Fed speakers, ECB president Mario Draghi will deliver a speech, and central banks in emerging markets will be busy as Mexico is expected to raise rates and India is expected to cut. The U.K. parliament will continue to debate and then vote this week on whether to trigger Article 50 and officially start the process of leaving the EU.
  • NAFTA. This week we’ll take a look at the politics behind NAFTA-the North American Free Trade Agreement-and its impact on U.S. trade, employment, and wages-as the Trump Administration continues to make changes to U.S. trade policy.
  • A technical look at things. Long-term technicals continue to look very promising, with multiple U.S. equity indexes breaking out to new all-time highs. This type of market breadth bodes well for a possible continuation of the equity bull market. One potential worry is seasonality, as the month of February is historically weak. Digging in more, in the calendar year following a presidential election, February is the worst month on average. One other near-term worry is overall market sentiment is rather optimistic. From a contrarian point of view, this could be a potential warning sign.

MonitoringWeek_header

Monday

  • Harker (Hawk)
  • ECB’s Draghi speaks in Brussels

Wednesday

  • UK: House of Commons to Vote on Article 50
  • India: Reserve Bank of India Meeting (Rate Cut Expected)

Thursday

  • Mexico: Central Bank Meeting (Rate Hike Expected)
  • China: Money Supply and New Loan Growth (Jan)
  • China: Imports and Exports (Jan)

Saturday

  • Fischer (Dove)

 

 

 

 

 

 

 

 

 

Important Disclosures: Past performance is no guarantee of future results. The economic forecasts set forth in the presentation may not develop as predicted. The opinions voiced in this material are for general information only and are not intended to provide or be construed as providing specific investment advice or recommendations for any individual security. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly. Stock investing involves risk including loss of principal. A money market investment is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although money markets have traditionally sought to preserve the value of your investment at $1 per share, it is possible to lose money by investing in such a fund. Investing in foreign and emerging markets securities involves special additional risks. These risks include, but are not limited to, currency risk, political risk, and risk associated with varying accounting standards. Investing in emerging markets may accentuate these risks. Treasury Inflation-Protected Securities (TIPS) are subject to interest rate risk and opportunity risk. If interest rates rise, the value of your bond on the secondary market will likely fall. In periods of no or low inflation, other investments, including other Treasury bonds, may perform better. Bank loans are loans issued by below investment-grade companies for short-term funding purposes with higher yield than short-term debt and involve risk. Because of its narrow focus, sector investing will be subject to greater volatility than investing more broadly across many sectors and companies. Commodity-linked investments may be more volatile and less liquid than the underlying instruments or measures, and their value may be affected by the performance of the overall commodities baskets as well as weather, disease, and regulatory developments. Government bonds and Treasury bills are guaranteed by the U.S. government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value. However, the value of fund shares is not guaranteed and will fluctuate. Investing in foreign and emerging markets debt securities involves special additional risks. These risks include, but are not limited to, currency risk, geopolitical and regulatory risk, and risk associated with varying settlement standards. High-yield/junk bonds are not investment-grade securities, involve substantial risks, and generally should be part of the diversified portfolio of sophisticated investors. Municipal bonds are subject to availability, price, and to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rate rise. Interest income may be subject to the alternative minimum tax. Federally tax-free but other state and local taxes may apply. Investing in real estate/REITs involves special risks such as potential illiquidity and may not be suitable for all investors. There is no assurance that the investment objectives of this program will be attained. Currency risk is a form of risk that arises from the change in price of one currency against another. Whenever investors or companies have assets or business operations across national borders, they face currency risk if their positions are not hedged. Technical Analysis is a methodology for evaluating securities based on statistics generated by market activity, such as past prices, volume and momentum, and is not intended to be used as the sole mechanism for trading decisions. Technical analysts do not attempt to measure a security’s intrinsic value, but instead use charts and other tools to identify patterns and trends. Technical analysis carries inherent risk, chief amongst which is that past performance is not indicative of future results. Technical Analysis should be used in conjunction with Fundamental Analysis within the decision making process and shall include but not be limited to the following considerations: investment thesis, suitability, expected time horizon, and operational factors, such as trading costs are examples. This research material has been prepared by LPL Financial LLC.

 

The Fed is Crushing the Dollar, and That’s Great for Stocks

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Provided by MarketWatch

The brutal U.S. stock-market selloff that dominated the first six weeks of the year has been erased—and investors might have the dollar to thank for that.

Slowing global growth, worries about a sharp devaluation in the Chinese yuan, stubbornly low oil prices, and the Federal Reserve’s decision to raise interest rates in December are all factors that investors have blamed for the turmoil in global markets this year.

But the market’s reaction to the outcome of Wednesday’s Federal Reserve meeting perhaps revealed the true culprit: the strong dollar.

“A lot of the market convulsions looked like they were coming from independent things. But they all had a common denominator and that’s the dollar,” said Binky Chadha, chief global strategist at Deutsche Bank, in a phone interview.

The Fed on Wednesday surprised investors by striking a more cautious tone—projecting just two rate increases in 2016 compared with its December forecast for four increases. The dollar fell sharply versus major rivals, with the ICE U.S. dollar index , a measure of the currency against six major rivals, falling to its lowest level of 2016 on Thursday.

The less aggressive tone has many currency strategists—including Vasileios Gkionakis, the global head of currency strategy at UniCredit—optimistic that the dollar will continue to weaken this year.

This bodes well for U.S. equities. Indeed, the Dow industrials and S&P 500   both turned positive for the year on Thursday. And investors are optimistic that the recent bout of volatility is over—at least, for now.

There are several ways by which the dollar exchange rate feeds through to other markets.

When the dollar is weak, crude oil—which is priced in dollars—becomes more affordable to buyers who use other currencies. This can boost demand, driving prices higher. Indeed, the dollar and prices for oil and other commodities have historically maintained an inverse relationship. Oil futures rallied sharply Thursday, pushing the U.S. benchmark  above $40 a barrel for the first time in 2016.

Stronger prices for oil and metals could offer some relief for beaten-down energy and mining firms.

Also, a weak dollar makes its easier for U.S. companies to turn a profit.

Since the second quarter of 2015, companies based in the U.S. have regularly blamed the strong dollar for weaker than expected earnings. This could well change when companies report second quarter earnings, with the ICE dollar index down nearly 5% from its level a year ago.

“A higher dollar had a negative impact on overseas earnings of U.S. companies over the past several quarters. As the dollar stabilizes and the economy continues to improve, we will start seeing better earnings,” said Colin Cieszynski, chief market strategist at CMC Markets.

To be sure, potential headwinds remain. After the second Fed rate increase, which many investors expect will happen in June, the dollar could resume its march higher.

But for now at least, the Fed has given investors one less reason to complain.

Written by Joseph Adinolfi of MarketWatch

(Source: MarketWatch)

The Devil’s Due: China Could Send S&P 500 Below 666

iStockphoto

Sometimes random events suggest a larger force is in control.

Like when the S&P 500 bottomed at 666 on March 6, 2009 (03/06/09), during the last bear market. That was just a little too perfect, pointing to a devilish influence behind the whirlwind of fear, greed, speculation and cheap credit that created and then crashed the housing bubble.

Now, noted bear Albert Edwards at Societe Generale warns, stocks are headed even lower, revisiting 666 on the way to the hellish price destruction that lies below.

Just look at what happened on Wednesday. The selling was persistent, unyielding and powerful as U.S. equities melted lower. There was no specific catalyst for the decline, only a growing sense of fear that policymakers both here and overseas have lost control of the situation: Energy prices keep weakening, currency volatility increases and the economic data continues to soften.

Much of the fear stems from concern that the Federal Reserve made a policy mistake when it raised interest rates by 0.25 percent in December, the first hike since 2006. Either they waited too long. Or they didn’t wait long enough. It’s not clear which just yet.

But the result is clear: Small-cap stocks are now down 22 percent from their June high, officially entering a bear market. Large-caps aren’t far behind: The NYSE Composite is down 16.7 percent from its May 2015 high.

Edwards lays the blame squarely on the Fed and other major central banks. Their “pursuit of negligently loose monetary policies since 2009 is a misguided attempt to boost economic growth via asset price inflation and we will now reap the whirlwind,” he wrote.

The crux of the problem is what’s happening in China, which is being forced to devalue its currency and, in the process, set off a global deflationary impulse that will hit U.S. manufacturing right in the face and worsen the commodity price decline slamming shale oil and materials producers. Poor energy and material earnings are driving expectations of another quarterly earnings decline for the S&P 500, which would mark the first three-quarter streak of falling profits since the financial crisis.

I’ll spare you by not delving into details like the impact on dollar-denominated Chinese corporate debt and the relationship between the on-shore yuan and off-shore yuan valuation rate, but Edwards believes we’re headed for a valuation bear market “that did not fully play itself out in March 2009” and has historically taken four to six recessions to fully manifest.

In March 2009 the Shiller 10-year Price-to-earnings measure of stock market valuation bottomed at 13.3x, way above the typical sub-7x nadir of valuation lows. Currently, that Shiller P/E is back above 26x.

Edwards delivers this chilling takeaway:

“If I am right and we have just seen a cyclical bull market within a secular bear market, then the next recession will spell real trouble for investors ill-prepared for equity valuations to fall to new lows. To bottom on a Shiller PE of 7x would see the S&P falling to around 550. I will repeat that: If I am right, the S&P would fall to 550, a 75 percent decline from the recent 2100 peak.”

Obviously, the Fed would aggressively fight this collapse in wealth with a likely decline in interest rates to -5 percent, accompanied by fresh rounds of quantitative easing.

Could this dark scenario get any darker?

The outbreak of an outright currency and trade war would do the trick. Already, according to the monthly World Trade Monitor, global trade declined for most of last year, the weakest performance since 2009. The U.S. just imposed punitive sanctions on Chinese steel imports of 256 percent. And leading GOP presidential contender Donald Trump has outlined an aggressive position on challenging China on trade.

Even without those developments, though, investors may have a devil of a time ahead.

Written by Anthony Mirhaydari of Fiscal Times

(Source: The Fiscal Times)

How China Could Trigger a Global Crisis

China
Wikimedia

When China sneezes, the rest of the world might not catch a cold, but it does feel bad for a couple of days. The question, though, is whether China is sicker than it seems and how contagious that would be for the global economy.

In other words, is China’s latest stock market selloff — the Shanghai index lost 15 percent of its value in the past six days — and currency devaluation just a blip or the beginning of a bust? I say latest because the same thing happened in August. That was our first real inkling that Beijing might not have as much control over its economy as it seemed. And now we know: it doesn’t. It’s made one ham-handed attempt after another to prop stock prices up to unsustainable levels—buying shares itself and banning others from selling—which only works as long as it keeps doing so. But more than that, it’s the fact that the government either can’t decide whether it wants a cheaper currency or can’t stop it from happening that hints at bigger problems under the economic hood. It’s enough that no less an authority than George Soros thinks this could be like 2008.

What’s going on? Well, China is trying to manage a slowdown that was always going to happen at the same time that it deflates a credit bubble that it wishes hadn’t happened. Either one would have been hard enough on its own, but together they might be too much for even the most competent government to deal with. That’s because Beijing needs to intervene even more to keep the economy growing today—at least as much as it wants—but loosen its grip on it to keep it growing tomorrow. So there are two dangers. The first is that a tug-of-war within the government leads to half-measures that don’t solve either problem. And the second is that fears over a tug-of-war might make these problems harder to solve than they already are. Still, we shouldn’t overstate this. It’s not like China’s economy is about to collapse. Its growth is real, if not as spectacular as it was before. It just might slow down further or faster than we thought, grinding down to 3 or 4 percent growth instead of 6 or 7 percent.

But let’s back up a minute. Why was it inevitable that China’s economy would shift down to a lower gear? Simple: its old growth model had run out. There are only so many people you can move from the farms to the factories—especially when you only let them have one kid—and so much infrastructure you can build before you run out. Now, China hasn’t quite reached that point, but it has gotten to the one where there aren’t as many people moving to the cities as before. And that’s enough. It not only makes it harder for the economy to grow as much, but also makes it harder for companies to export as much now that, without a steady stream of would-be workers holding down wages, they have to pay people more.

You can probably see where this is going. If workers are making more, they can spend more—and that, rather than selling things to foreigners, can power the economy. But that’s a lot harder than it sounds. First, you need a stronger safety net so people feel more comfortable splurging. Then, you need to give them time for their habits to change. But, most importantly, you need to keep adding higher-paying jobs.

It’s this last part that would force Beijing to do what it doesn’t want to: give up at least some of its control over the economy. Think about it like this. In the short-term, wages are going up because workers have more bargaining power, but, over the longer-term, that will only continue if productivity increases. Workers, in other words, have to make more or better stuff to make more money. How do you do that? Well, the government would have to start deregulating the economy so businesses could expand where they had to and stop supporting zombie companies that were blocking the way. Beijing has actually talked about this quite a bit, even commissioning a rap song about supply-side reforms, but, as we’ve seen with stocks, this determination to give markets a “decisive” role in the economy has only lasted as long as they give the “right” answer.

That brings us to problem number two. Everything we’ve been talking about, this shift from a saving to a consuming society, well, takes time. So what is China supposed to do until then? Beijing’s answer has been for everyone to run up a lot more debt—and by “a lot,” I mean four times as much. Indeed, between 2007 and 2015, China’s total debt, including the government, households, and corporations, increased from $7 trillion to $28 trillion. That’s 282 percent the size of its economy, which is more than we have relative to ours.

Now, most of this hasn’t directly been on Beijing’s books, but has rather come at Beijing’s direction. The idea, at least, made sense. That was to replace all the foreign customers who disappeared during the financial crisis with even more infrastructure spending until Chinese customers were ready to take their place. In practice, though, it hasn’t worked out that well. Developers built cities where nobody lives, companies built factories that nobody needs, and local governments built airports that nobody uses. It hasn’t all been wasteful—and who knows, 10 years down the line, what is today might not be—but right now it sure looks like a bubble not all that different from the one we had. Consider this: more than half this debt is tied to a property market that, since 2008, has gone up more than 60 percent in the 40 biggest cities. So far Beijing has been able to keep prices from falling too far, but only by letting people pile new debt on top of the old. That is not a long-term solution.

But it’s hard to tell how much this will hurt. It’s not just that nobody believes China’s official numbers. It’s that even if you did, they might not be worth that much anymore. As Larry Summers points out, about 20 percent of China’s growth the past year has come from financial services despite the fact that it was already a pretty big share of the economy. That’s as close as you’ll get to a flashing red warning sign saying “bubble”, as we found out with our own.

So what’s a better way to tell how China’s economy is doing? Well, how about how much people are willing to bet on it—or not. The simple story is that money has been pouring out of China the past year or so, and that actually accelerated in December. Part of this is probably due to wealthy Chinese moving their ill-gotten gains out of the country to stay a step ahead of the government’s corruption crackdown. But a bigger part is probably that people who thought they could make a quick buck investing in China are changing their minds now that it’s slowing down—which is contagious. Here’s why: when people move their money out of China, what they’re really doing is selling their yuan to buy, say, dollars. But that’s just another of way of saying that there isn’t as much demand for yuan—so its price falls. And if that happens, other people who hadn’t wanted to get their money out of China might decide that they better do so before it loses any more value.

That’s why, Beijing has actually been trying to stop its currency from falling too much. It has allowed the yuan to depreciate modestly, but if it was left up to the market, it would have fallen a lot more, given the economy’s fundamentals. The only problem with this strategy is that might be the worst thing it could have done. The best way to think about that is to think about what would have happened if it’d just let the yuan fall as far as markets wanted it to. And the answer, as Paul Krugman explains, is that it would trigger a trade conflict with the United States (where politicians are quick to claim China is manipulating markets) and elsewhere. It would be a big drop, probably bigger than the fundamentals say it “should,” but then people might see it as properly valued and perhaps even expect it to start rising—which it then might.  And it’d be over. And best of all, Beijing wouldn’t have to spend any of its war chest of reserves. That, after all, is how the government tries to prop up its currency: by buying yuan with some of the dollars it’s stored up.

But by buying just enough to keep the yuan from falling suddenly, while still allowing it to trend slightly lower, the government is telling people that they’re right to move their money out of the country since it will, in fact, be worth a little less if they wait. That puts more pressure on the yuan to fall, and more pressure on the government to keep it from falling by spending its reserves. The end result is that the currency might fall just as much as it would have if you let it fall all at once, but at the cost of a lot of its war chest. And that is a real cost. It sucks even more money out of the economy, which, in turn, forces the government to cut interest rates just to keep growth from slowing down even more. The lesson, then, is that you’d be better off either spending so many reserves that your currency doesn’t fall at all, or just letting it go. A controlled fall is the most expensive kind.

China’s economy might be a riddle wrapped in a mystery inside an enigma of dodgy data, but its currency is telling a clear story. The people who have the most on the line—that is, ones with money in the country—are worried that the economy is going to slow down a lot more than the government says. The worry is that if, after spending down its reserves, China is forced to let the yuan slide, other countries might follow so their exports don’t lose competitiveness—and emerging markets that borrowed in dollars might found their debts too hard to pay back. That wouldn’t quite be 2008 all over again, but it’d be close enough for a global economy that is still struggling to recover from the last one.

The rest of the world will be okay if China is just sneezing, but not if it’s more than that.

Written by Matt O’Brien of The Washington Post

(Source: The Washington Post)

Fourth Quarter, a Look Back…

ECB Announces Monthly Rate Decision
Photographer: Hannelore Foerster/Bloomberg

The Federal Reserve pulled the trigger. At the December Federal Open Market Committee meeting, the Fed finally acted, tightening monetary policy by raising the funds rate from 0.25 percent to 0.50 percent. It’s important to remember the Fed doesn’t actually set interest rates. It takes actions designed to influence financial behaviors. The Fed has given rates a push, it remains to be seen whether its efforts will bear fruit.

The European Central Bank (ECB) acted, too. Although, its monetary policy moved in a different direction, offering additional stimulus measures to support European economies. Investors were enthusiastic when the ECB announced its intentions; however, markets were underwhelmed when the economic measures delivered were less stimulative than many had expected.

China’s currency gained status. The International Monetary Fund decided to add the Chinese yuan (a.k.a. the renminbi) to its Special Drawing Rights basket, effective October 1, 2016. After the renminbi is added, the U.S. dollar will comprise 42 percent of the basket, the euro will be 31 percent, the renminbi will be 11 percent, the Japanese yen will be 8 percent, and the British pound will also be 8 percent.

Congress tweaked Social Security. The Bipartisan Budget Act of 2015 (BBA) averted a U.S. default and deferred further discussion of U.S. debt and spending levels until after 2016’s presidential and congressional elections. It also did away with two popular social security claiming strategies. The restricted application strategy was discontinued at the end of 2015, and file and suspend strategies will be unavailable after May 1, 2016.

Medicare premiums go up, but not for everyone. The BBA also limited increases in Medicare premiums. About 14 percent of Medicare beneficiaries will pay higher premiums in 2016. The new premium will be $121.80, up from $104.90 in 2015. Original proposals suggested the premium amount increase to $159.30.

Why Did China Devalue Its Currency? Two Big Reasons

© Rolex Dela Pena/European Pressphoto Agency
© Rolex Dela Pena/European Pressphoto Agency

Here are two things that China’s government wants very badly: first, for its economy to remain on an even keel, keeping growth and employment high. Second, for its currency, the renminbi, to become a pre-eminent global currency that helps promote the country’s diplomatic goals and solidify the country’s centrality to the global economy.

Frequently those goals are in conflict. But Tuesday, it found a way to advance both at once.

That’s how to make sense of some blockbuster news out of Beijing that the country will adjust how it manages the renminbi to make the currency’s value respond more closely to market forces.

The immediate result was a de facto devaluation, with the Chinese currency falling 1.8 percent versus the dollar and 2.2 percent versus the euro Tuesday. Those are big moves for the renminbi, considering that the government had a policy of maintaining a strict trading band — enforced with both legal restrictions on the transfer of capital and the government’s trillions in reserves. Usually, the renminbi will move only a few hundredths of a percent against the dollar in a given day; the largest move this year was 0.16 percent.

But a roughly 2 percent shift in the value of a currency, even a major one, is not that big a deal, and certainly not the kind of thing that would earn blaring headlines about a devaluation. The dollar has risen 22 percent against the euro in the last year; the Japanese yen plummeted 24 percent against the dollar in late 2012 and early 2013. What makes the Chinese move fascinating is what it says about China’s approach to its currency and economy, and about the country’s role in the global financial system in the future.

The Chinese economy is unquestionably in a rough patch, and maybe something worse. Growth is downshifting from the double-digit rate of a few years ago, and the country’s investment-and-exports-driven growth model is looking exhausted after driving a generation of prosperity. A stock market crash in the last few months hasn’t helped.

But a hidden cost of the Chinese government’s strategy of keeping the renminbi within a narrow trading band versus the dollar has been that China has been unable to use one of the crucial tools most countries use when they’re in an economic slowdown.

The renminbi on Monday was at about the same exchange rate versus the dollar that it was in mid-December. But in that span, the dollar index was up 8.7 percent, meaning the dollar — and by extension the renminbi — were up that much against the currencies of other advanced nations like the euro, the Japanese yen and the British pound.

Linking the value of its currency to the dollar has had benefits, but in the last year has come at a big cost: It has resulted in the renminbi’s rise against competitors and trading partners at a time the economic fundamentals of China would argue for it to fall.

Meanwhile, China is looking to assert more of a leadership role in the global economy, and an important piece of that is establishing the renminbi as a reserve currency. The dollar and the euro have a reach and usefulness far beyond the borders of the countries that issue them, and China would like the yuan to have a similar sway in global trade and finance, especially within Asia.

But you can’t really be a global reserve currency when you maintain all the restrictions that China insists upon in the interest of keeping control of its domestic economy. The dollar wouldn’t play its central role in global finance if the American government made it illegal to exchange it for other currencies in many circumstances or used legal prohibitions and aggressive interventions to keep its value from fluctuating in response to market forces.

In other words, China has wanted some of the diplomatic benefits of the renminbi’s becoming a more important currency abroad, without paying the price at home.

Just last week, the International Monetary Fund said that the renminbi was not quite ready for prime time for inclusion in the basket of currencies it uses for “special drawing rights,” a reserve asset that currently is a mix of dollars, euros, yen and pounds. Christine Lagarde, the I.M.F.’s managing director, said China needed to make its currency more “freely usable.” And the policy change on Tuesday, by moving closer to a world in which markets determine its price, is a step in that direction.

That doesn’t mean it was without cost. The cheaper renminbi will mean higher inflation and will create an even greater burden for Chinese companies that owe money in dollars, potentially setting off a new round of failures. Perhaps more important in the long run, as China liberalizes its currency, it gives up a crucial tool that the government has used to manage the economy for years and protect itself from being buffeted by global economic forces. China’s leadership has been reluctant to give up that power, and that’s why Tuesday’s announcement came as such a shock across global markets.

But it isn’t often that a policy choice helps achieve two big national goals at once. And when faced with one, it appears China’s leaders were willing to give up a little bit of power for, they hope, better economic results at home and a bigger role in the global financial system abroad.

Written by Neil Irwin of The New York Times

(Source: The New York Times)

Dow Closes Down More Than 200 Points on Surprise Yuan Devaluation

Provided by CNBC
Provided by CNBC

Stocks closed lower by about 1 percent on Tuesday after an unexpected move overnight by the People’s Bank of China to depreciate the yuan by nearly 2 percent.

“The major concern is, the prospect of a China hard landing is more ominous as far as its impact on global growth,” said Eric Wiegand, senior portfolio manager at U.S. Bank’s Private Client Reserve.

The Dow Jones industrial average ended 212 points lower, wiping out most of Monday’s gains. Apple briefly plunged more than 5 percent and Caterpillar fell more than 2.5 percent to lead declines. The index’s 50-day moving average fell below its 200-day moving average, a bearish condition many analysts term a “death cross.”

On Monday, the blue-chip index snapped its first seven-day losing streak in four years with a 241-point rise.

Biotech stocks and Apple outweighed Google’s 4 percent jump to pressure the Nasdaq Composite off 1.2 percent.

Sharp declines in oil pressured the energy sector to give back much of Monday’s gains, dropping nearly 2 percent as one of the greatest decliners in the S&P 500.

Renewed concerns about a deeper slowdown in the world’s second-largest economy increased negative sentiment.

It’s the “interpretation that the U.S. dollar is going to further strengthen against the Chinese yuan and be a further headwind against U.S. multinationals,” said Mark Luschini, chief investment strategist at Janney Montgomery Scott.

“I’m a little surprised (China) did this because they had plenty of room to cut interest rates,” Luschini said.

The drop in the daily peg to 6.2298 renminbi against the U.S. dollar, down from 6.1162 on Monday, was the largest one-day move in more than two decades and took the currency back to levels from three years ago. The central bank described the decision as a “one-off depreciation.”

“I think the market’s perception is if China is doing that they’re really worried about their economy,” said Jason Leinwand, managing director at Riverside Risk Advisors. “Any currencies that have direct ties with China will be weakened.”

The U.S. dollar index traded mildly higher, while the euro held above $1.10 on a bailout deal between Greece and its creditors. The yen was weaker against the dollar, near 125 yen.

European stocks closed sharply lower, with the German DAX off more than 2.5 percent, on the yuan move. Asian stocks ended mostly lower, with the Shanghai Composite flat.

“This news is negative for exporters (such as automakers) and luxury goods makers as well as other companies that derive foreign exchange revenue from China and other parts of Asia,” said Ilya Feygin, senior strategist at WallachBeth Capital.

He noted that the currency instability benefits Treasurys and gold.

Treasury yields fell as traders piled into dollar-denominated assets, with the 10-year yield briefly hitting its lowest level since June 1 before trading near 2.14 percent and the 2-year yield at 0.67 percent.

The Treasury Department auctioned $24 billion of 3-year notes at a high yield of 1.013 percent at 1:00 p.m. ET.

Gold rallied on Monday to its highest level since the end of June. Gold futures traded near $1,110 an ounce in afternoon trade.

Investors also watched Google, which unexpectedly announced after the close Monday that it will become part of a new publicly traded entity called Alphabet. Shares will still trade under the tickers GOOGL and GOOG. Class A shares jumped more than 3.5 percent in the afternoon.

Oil extended a recent decline. Brent crude was down more than 2.5 percent to below $49 a barrel, while U.S. crude briefly fell below $43 a barrel for the first time since March.

On Monday, dollar weakness and a refinery outage helped crude rally nearly 2.5 percent from a near five-month low earlier in the session

Crude oil futures hit a five-month intraday low of $42.69 and settled down $1.88, or 4.18 percent, at $43.08 a barrel, a six-year low. Gold futures ended up $3.60 at $1,107.70 an ounce.

On the data front, preliminary second quarter productivity was up at an annual rate of 1.3 percent, while unit labor costs were up 0.5 percent.

Wholesale sales rose 0.1 percent in June, the weakest since March of this year, while inventories topped expectations with a gain of 0.9 percent. May’s figure was revised lower to 0.6 percent from 0.8 percent.

“I think once investors get past the yuan devaluation we can focus on the (U.S.) economic picture, which remains good,” Luschini said.

Most analysts expect the Federal Reserve will find enough support from economic data to raise rates as early as September.

“The overnight devaluation of the Chinese yuan will likely be seen by Fed officials as a minor headwind to growth, but is not significant enough to change our base view of September liftoff,” J.P. Morgan said in a note. “The yuan has a 21.3 percent weight in the Fed’s broad dollar index, and so simply taking the 0.4 percent dollar change implied by the PBoC action at face value would imply perhaps a few hundredths off growth over the next one to two years (using a rough rule of thumb that 10% in the broad dollar subtracts about 1% off the level of GDP over time).”

Before the opening bell, Towers Watson posted quarterly results that beat expectations on both the top and bottom line.

In other earnings news, Shake Shack posted results after the close Monday that beat on both the top and bottom line. The restaurant chain also raised its full-year guidance.

Kraft Heinz reported a decline in sales at both its Kraft and Heinz divisions. Combined results for the recently merged firm were not reported.

Computer Sciences, Symantec, Cree and Cyber Ark Software will report after the bell.

The CBOE Volatility Index (VIX), widely considered the best gauge of fear in the market, traded above 14.

About seven stocks declined for every three advancers on the New York Stock Exchange, with an exchange volume of 505 million and a composite volume of nearly 2.5 billion in afternoon trade.

Written by Evelyn Cheng of CNBC

(Source: CNBC)