Big Trouble in China?


0818 wellmanthumbBY JASON NORRIS | CFA

Earlier this month, the People’s Bank of China (PBoC) announced they were going to devalue their currency, the Renminbi. While the amount of the targeted change was to be roughly 2 percent, investors read a lot more into the move. The Renminbi had been gradually appreciating against the U.S. dollar (see chart) as to attempt to alleviate concerns of being labeled a currency manipulator.

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BY JASON NORRIS | CFA

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(Photo courtesy: Japanexperterna.se)

Earlier this month, the People’s Bank of China (PBoC) announced they were going to devalue their currency, the Renminbi. While the amount of the targeted change was to be roughly 2 percent, investors read a lot more into the move. The Renminbi had been gradually appreciating against the U.S. dollar (see chart) as to attempt to alleviate concerns of being labeled a currency manipulator.

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The PBoC stated that the devaluation was an attempt to allow greater market forces more control over the currency. However, the timing is dubious. The news came out only a few days after China reported stagnant export data. With a weaker Renminbi, Chinese exports will be more competitive globally. This may also signal the the Chinese economy not growing at the ~7 rate most recently reported.  After listening to company conference calls over the past the several weeks, China was cited as the main weakness across multiple industries. China’s growth has been a tailwind for large multinationals as well as commodity exposed companies; however, we may be seeing the economy move to a more “normal” growth.

This move is also on the heels of the “bursting” of their domestic stock market bubble. From mid-2014 through June 2015, the Chinese domestic stock (Shanghai A Shares1) market rose over 250 percent.

  • 1   Shares in mainland China-based companies that trade on Chinese stock exchanges such as the Shanghai Stock Exchange and the Shenzhen Stock Exchange. A-shares are generally only available for purchase by mainland citizens; foreign investment is only allowed through a tightly-regulated structure known as the Qualified Foreign Institutional Investor (QFII) system.

    Read more: http://www.investopedia.com/terms/a/a-shares.asp#ixzz3jBPoqRCX 

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When the bubble burst and the selling began, the Chinese government began restricting trading, specifically selling the majority of securities traded on the the domestic markets to attempt to prop up the indices. While this may work in the short term, it is not a long-term solution. In the interim, the A-shares have fallen close to 30 percent from their recent peak. While early investors still have nice profits, the question is out on how many people entered the market close to the top and thus, are in the “red.” Since a decline in wealth can effect the demand for goods, we don’t yet know the full ramifications of deflating this bubble.

These events have not helped the world’s largest company, Apple. It’s down over 10 percent from its recent high as investors’ concerns over China have weighed on the stock. Even though Apple cited China as being strong just a few weeks ago, recent data points have investors nervous. In the June quarter, China accounted for over 25 percent of Apple’s iPhone revenue. The iPhone is 66 percent  of Apple’s total revenue and its highest margin product. If the the Chinese consumer decides to defer a purchase due to recent equity volatility or higher price (due to FX devaluation), this may lead to lower-than-expected iPhone growth and continue to pressure the stock. What Apple has going for it is a healthy cash balance, strong technical innovation and an attractive valuation. September’s launch of the iPhone 7 will be interesting to watch.

Back at the Ranch

While international markets are showing increasing volatility, the U.S. economy continues to chug along. Recent home sales data show 10 percent  year-over-year gains, driven by growth in single family homes. This has been supported by strong earnings reports from Home Depot and TJX Companies’ home goods division. The U.S. consumer appears to be taking the savings from low gas prices and reinvesting back into their largest asset, their home. We do not believe that housing will be materially affected when the Fed finally starts to raise rates. Mortgage rates are still relatively low (see chart).

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The Coin Flip
The other side of the story – from Oregon’s perspective 

With the U.S. economy improving and consumer spending slowly picking up, parents aren’t passing that cash down to their kids … or at least the tooth fairy isn’t. In a recent survey from Visa, American children are receiving an average of $3.19 per tooth. This is down $0.24 from 2014. The tooth fairy is even less generous in Oregon, leaving around $2.00 per tooth. Whether it’s from the tooth fairy, chores or good grades, it’s never too early to teach children about their spending rates and the power of compounded interest. As an investment management firm primarily serving adults, it’s an important topic for any age. Junior Achievement provides good resources for families on such topics.

Jason Norris, CFA, is executive vice president of research at Ferguson Wellman Capital Management. Ferguson Wellman is a guest blogger on the financial markets for Oregon Business.