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Is China’s Unexpected Lowering of the Yuan Something of Significance or Just Noise?

The Chinese unexpectedly lowered the exchange rate of the yuan, the first such devaluation since 1994. Officials state this is a one off event and a “one-time adjustment.” The newswires are filled with possible ramifications including a proverbial “race to the bottom via competitive devaluations” to stimulate trade and economic growth. Unfortunately only history will suggest if yesterday’s devaluation was something of significance or just noise.

Equity markets, originally led by energy and commodities, sold off considerably on the devaluation. Oil retraced a large part of their losses but then technology further sold off. The dollar rallied as did the Treasury. Oil is now at a six year low, falling over $17 barrel or 30% since June 30. This is one of the sharpest declines in history. Energy companies have also been crushed, declining anywhere between 25% and 60% since June 30.

Calling a bottom is impossible. Perhaps the only concrete statement to make is that the oil market/stocks are closer to bottom today than yesterday. Many thought last Friday was the proverbial “capitulation day.” A question that is now beginning to gain considerable attention is whether or not the indices are about to “roll over.” As noted many times, approximately 70% of NYSE listed stocks are below their 200 day moving average lines, with the typical stock posting almost a 23% decline according to CNBC. The Dow violated its 200 day moving average about 10 days ago and now the 50 day moving average has crossed over the 200 day. I am not technical analyst but trading has been dominated by technology and such an event is typically bearish.

Changing topics, in my view little attention has been focused upon declining productivity rates. Efficiency grew 0.3% in the 12 months ended June compared with 3% a year in average in the decade ended 2005. Productivity over the last three years grew at an average of 0.5%. Companies are not spending funds on equipment and infrastructure, forgoing investment of their profits for tomorrow’s growth. I can list a litany of plausible reasons for the lack of investment but ultimately such a decline will negatively impact profits and increase potential inflation rates. Several times I have opined about the possibility of a market and economic melt up as funds are suddenly shifted to a more productive use, including the broadening number of stocks participating in any market advances. Is this wishful thinking? Liquidity, excess bank reserves, etc. are at record levels idly sitting.

If history can serve as a guide, these funds will be utilized in a more efficient manner. But what will be the event? We can list 187 possible events and it will be the 188th that history will view as the catalyst.

Last night the foreign markets were down. London was down 1.15%, Paris down 2.25% and Frankfurt down 2.31%. Japan was down 1.58% and Hang Sang down 2.38%. The Dow should open sharply lower as Chinese shares tumbled in the wake of the devaluation that is suggesting that its growth rate is slowing more than expected. As stated many times, China is an export dominated country, an economic system that is inherently risky given that it is dependent upon others for its growth. The 10-year is up 7/32 to yiewld 2.11%.

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Ken Engelke

Chief Economic Strategist Managing Director

The views expressed herein are those of Kent Engelke and do not necessarily reflect those of Capitol Securities Management. Any opinions expressed are statements of judgment on this date and are subject to certain risks and uncertainties which could cause actual results to differ materially from those currently anticipated or projected. Any future dividends, interest, yields and event dates listed may be subject to change. An investor cannot invest in an index, and its returns are not indicative of the performance of any specific investment. Past performance is not indicative of future results. This material is being provided for informational purposes only. Any information should not be deemed a recommendation to buy, hold or sell any security. Certain information has been obtained from third-party sources we consider reliable, but we do not guarantee that such information is accurate or complete. This report is not a complete description of the securities, markets, or developments referred to in this material and does not include all available data necessary for making an investment decision. Prior to making an investment decision, please consult with your financial advisor about your individual situation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. If you would like to unsubscribe from this e-mail distribution, please reply to this e-mail and indicate that you wish to unsubscribe in your response.