Frankly Speaking

This Market Volatility is Chinese to Me

The recent drop in the U.S stock market was not an isolated incident. We saw foreign markets around the world dropping in similar fashion. So what was behind all the nervousness? In one word, China. Investors have been worried for some time that the Chinese economy has been slowing down. Since China is a significant part of the world economy investors figure a slowdown may have a ripple effect on other countries that do business with China. But why the sudden reaction to a slowdown that has been unfolding for a long time?

Predicting the path of any economy is difficult enough but China raises that difficulty to a whole new level. As a communist country its economy is highly “managed” by its government. Chinese officials have historically given outsiders little insight into their economic planning and policies. In that environment investors can be easily blindsided. That's exactly what happened recently when the Chinese government suddenly devalued its currency (the yuan) in an attempt to stimulate its economy. A devalued currency effectively marks down the cost of Chinese goods to foreign buyers like the U.S. The reaction of investors was not good. They questioned if this was a sign of desperation and perhaps the Chinese economy was even worse than they thought. Within days the other shoe dropped as other countries who deal with China also devalued their currencies in an attempt to level the playing field and keep the cost of their own goods competitive on the world market. This effectively neutralized the advantage China sought in its devaluation move. This widespread adjustment of currencies by many countries caused investors even more concern.

In times of turmoil, sometimes it's best for investors to take a step back and examine the big picture. Here's what I see. First, we buy significantly more from China than we sell to them. Given the cost of Chinese goods just got cheaper, that is a money saver for us. Second, the U.S economy remains on solid ground. Any economic drag created by a drop in our exports (as a consequence of the fall in the Chinese yuan) will be outweighed by the savings we reap in our imports from them. Third, this reminds me of the drop in oil prices that started last year. Initially markets reacted negatively, mostly because they were caught off guard by the sudden unexpected drop. Later, markets recovered as cooler heads prevailed and we learned to like the lower energy costs we had all been wishing for. The drop in the yuan may follow the same pattern. It was sudden and unexpected, but we may yet come to love it. Long term investors should not let recent volatility change their strategies.

Sincerely,

Frank Rizzo
President, Branch Manager
Certified Financial Planner, CRC