What China Means For Your Client Portfolios

Chinese macro-economic analysis was not in any of our respective broker training programs when we all started in the business, but the bottom line is that China is making your clients’ portfolios fall.The market in now teetering on support, and understanding China is now important for all advisors and investors.In the excerpt below we provide some analysis that explains, in plain English,

1) What is happening in the Chinese economy,

2) Why it is making US stocks fall to multi-month lows,

3) What indicators will tell us when this requires more defensive positioning, and

4) How to hedge a further decline

Before getting into specifics, though, understand that at the heart of this China angst is the growing belief that Chinese authorities aren’t in control of the economy.

Growth has been slowing in China for a while, but in the last month we’ve seen huge stock market declines (more than 30%) and Chinese regulators failing to stop the selling by 1) Prohibiting the short sale of stocks, 2) Banning government entities from selling shares, and 3) Accusing certain market participants of engineering drops in specific stocks.

Then, this week, Chinese authorities surprised the market again by depreciating the yuan 2%, the biggest single drop in years.  Then the yuan fell more last night, one day after Chinese authorities said the drop was a “one-time event.” 

All of this implies they aren’t in control of the economic situation, and that’s really why markets are falling right now.

It’s the same thing with your clients – they get nervous when they think that you aren’t in control of their portfolios, so while we all know that following macro-economic trends in China doesn’t get new clients or increase AUM, right now you need to be a China “expert,” so you can show your clients that you are in control of the situation and have a plan to protect portfolios, and in doing so solidify that client relationship for years to come.

This week, we’ve been that China “expert” for our paid subscribers, and given them the talking points they need to 1) Understand what’s happening, and 2) Be able to communicate the facts including their plan for client portfolios. 

Our job at The Sevens Report is to do that every trading day, regardless of the latest macro scare, and make sure our clients have the information they need across asset classes:

  • Stocks
  • Bonds
  • Currencies
  • Commodities, and
  • Market Sensitive Economic Data

That’s what we do for paid subscribers every trading day at 7 AM, and it’s why we believe we’re the best value in the independent research space. 

As a courtesy, we’ve included an excerpt from today’s Report that details what’s going on in China, and what will make it a bearish game changer.

Why China is Making Stocks Fall (Sevens Report Excerpt). 

China devalued its currency by nearly 2% yesterday, the biggest cut in over 25 years. That devaluation resulted in a sharp drop in US stocks and commodities, mainly in reaction to rising general worries about Chinese economic growth.

Importantly (and disconcertingly) oil made new multi-month lows and is inching closer to $42.41 (the recently established 6 year low). And, since our general thesis for market stabilization is predicated on commodities and sections of the bond market stabilizing, that’s not good.

Bigger picture, we view increased certainty regarding the first Fed rate hike as a positive for markets, and anything that further clouds that (as this devaluation does) isn’t helpful for stocks as it keeps markets stuck in the 2,050-2,130 range.

Looking specifically at the devaluation, there were multiple “official” reasons cited for why this was done yesterday, including closing the gap between the official yuan valuation and the lower spot market valuation. But the truth is that China remains an export-driven economy, and authorities need to boost growth—and this is a powerful way to do so.

Market Implications (Winners & Losers):

Loser #1:  Commodity Sector.  The biggest loser is the commodity sector. Obviously increasing the price of commodities in China (by weakening the currency) isn’t positive for demand, and while it likely won’t result in huge demand destruction, with commodities so beat up and sentiment so negative, it’s just causing a pile-on at this point.

Loser #2:  Europe.  European shares which got hit hard on the news yesterday and today as this move is thought to potentially reduce exports from Europe to China, specifically high-end luxury goods (think Louis Vuitton). COH and TIF were down early yesterday on this general theme. But, we don’t view this as a material negative “game changer” for HEDJ or our “Long Europe” theme. Our Long Europe thesis is based on a domestic economic recovery—not on growing exports to China.

Winner:  Big US Importers.  Some of the big US importers will benefit from cheaper “stuff” from China. Case in point, WMT was up on the news yesterday, as was HD.   These and other large importers that sell mostly domestically will benefit from increased margins. This does generally further confirm our thesis of outperformance from domestic-focused retailers and US consumer oriented companies.

Effect on the Fed: The devaluation news is being taken as very “dovish” as the general idea is that macro uncertainty and a stronger US dollar will cause the Fed not to hike in September as the stronger dollar remains a headwind on US exports, and that’s likely to get worse.

But, while it adds to the uncertainty surrounding a September hike, we do not view yesterday’s yuan devaluation as enough, by itself, to cause the Fed not to hike in September, assuming economic data stays on pace.

It does make the August economic data even more important, however, and retail sales tomorrow will take on added significance.

When This Becomes a Bearish Game Changer

We have been through enough of these emerging market based scares to know that watching headlines and listening to pundits is a fool’s errand. The only way to tell whether a macro scare like China is becoming a bearish game changer that requires more defensive positioning in client portfolios is to watch the leading indicators tied to those key markets. 

We’ve identified those leading indicator ETFs, and when China sentiment and the yuan stabilize, so will markets – and the leading indicator ETFs we are watching will tell us when that is happening, regardless of what the pundits or headlines say.

The two leading indicators we are following will bottom before the broad market because they are tied to China/commodities/and emerging markets.  They broke before markets, and they will bottom before markets. 

Our paying subscribers know these ETFs, and more importantly, they also know we are watching these ETFs for them, so they can stay focused on their clients.

Finally, if clients are getting especially nervous due to the declines and you’re looking to propose or use a hedge, we again identified one of the best pure hedges (an ETF that has specific emerging market/commodity exposure) out there, and gave our paid subscribers the ETF again in yesterday’s Report.

Bottom line, it’s been all hands on deck here the last few mornings, because markets are now at the tipping point we’ve been worried about for some time.

Our paid subscribers trust us to get these markets right, and to give them independent, plain English analysis on these markets every day at 7 AM, along with key indicators to watch and hedges to use, should this market truly break down from here.

Click this link to start your quarterly subscription and ensure that you have the daily macro analysis you need to navigate this increasing volatile market. 

We Find the Leading Indicators

1. In January 2014, when the S&P declined 7% in three weeks, we correctly identified that emerging market currencies were the “reason” for the drop, and identified the Turkish Lira as the key indicator to follow.  When it bottomed, stocks bottomed, and our subscribers knew it.

2. Last April, when the S&P 500 declined 4% in two weeks, we alerted our subscribers that the “momentum” sectors of internet stocks and bio-techs were responsible for the drop, and specifically identified QNET and NBR as two leading indicators to watch.  When they bottomed, stocks bottomed, and our subscribers knew it.

3. During the September/October declines, our subscribers knew junk bonds (and the ETF JNK) were the leading indicator for the market.  When JNK bottomed, so did the market.

4. Recently, as early as November we told our subscribers that oil, XLE and the Dollar Index were the leading indicators of markets, and until the first two stopped declining and the latter stopped rising, stocks would be under pressure.

Our ability to identify key leading indicators has had a direct benefit to our subscribers, and I know that because they’ve told me.  One subscriber (an FA at a bulge bracket firm) wrote to us saying:

“Thanks for your continued insight; it has saved my clients over $2M USD this year…Keep up the great work,” 

We watch all asset classes to generate clues and insight into the near term direction for stocks, and while we are happy stocks are grinding relentless higher, our job is to remain vigilant to the next decline.

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Best,
Tom

Tom Essaye,
Editor of The 7:00’s Report

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