It is often said that when China sneezes, Asia catches the flu. As China’s economic might has grown over the last decade, we’ve come to learn that the virus has the potential to spread a bit further. On the heels of multiple market events, many global assets seem to have entered the “correction” phase – down more than 10% – leaving many investors wondering if this is the beginning of a larger bear market (i.e., a 20% loss or more).

Looking back at June and July
Market volatility began in China in June through July, as the local Shanghai and Shenzhen stock exchanges fell over 30% from their highs. In response, the Chinese government opted to intervene in the markets – postponing initial public offerings (IPOs), prohibiting large sales by institutions and establishing a $19 billion stabilization fund to buy equities. For some investors, these actions were an indication that China’s financial authorities were losing control of their domestic stock market. Moreover, Beijing’s market interventions don’t appear to have worked.

Devaluation and global response
During the week of August 16, the People’s Bank of China effected a 3% devaluation of the country’s currency, the renminbi (RMB). Investors worldwide took the move as a sign that China was trying to protect its faltering exports – and that the Chinese economy may be slowing faster than previously thought.

The fallout
The damage from economic turbulence in China has been swift and wide spread. Global equities experienced significant across-the-board declines on August 20th, 21st, and 24th. Given China’s voracious appetite for resources, signs of a slowdown have also affected commodity markets – including oil and copper prices. Beijing’s currency devaluation has also increased pressure on emerging market economies, many of which are driven by trade with China.

Healthy Correction of Bear Market?
Only in hindsight will we know the true nature of the August selloff, but there are some data points that hint at the nature of the market. One commonly cited data point is the Chicago Board Operations Exchange (CBOE) Volatility Index, or VIX, a measure of anticipated (30-day) market turbulence*. The VIX jumped from below 13 to over 40 during the selloff. While volatility has increased at the start of past bear markets, these spikes often turn out to be overreactions to short-term events. The VIX was elevated for some time before the Tech Bubble of 2000-02 and the Global Financial Crisis of 2007-08. Other than simply reacting to volatility, it is also helpful to account for global fundamentals. For example, global monetary policy remains accommodative, with both the European Central Bank and the Bank of Japan focused on near-zero interest rates and their quantitative easing programs, which are aimed at fostering market liquidity and economic growth. Perhaps more importantly the United States – the world’s largest economy – continues to gradually pick up steam, with continued job growth, robust housing activity and an automobile market that has returned to pre-crisis volumes.

A durable approach to market events
Worries about China are not unfounded. If the world’s dynamic engine of growth is slowing dramatically, markets will likely remain under pressure. However, many key indicators of a bear market remain absent and the global economy is growing, not shrinking. For investors, episodes of market turmoil such as the events of late August reaffirm the importance of a durable portfolio that is focused on the long term. Investors who are risk-focused and diversified can be better protected from day-to-day market gyrations and can be positioned to take advantage of changes in values across asset classes. Moreover, many actively managed portfolios work to uncover potential growth opportunities amid broader shifts in investor sentiment. For more insights on how economic conditions in China may impact markets in the latter half of the year, visit the Navigating Today’s Markets section of durableportfolios.com.


* The CBOE Volatility Index® (VIX®) is a key measure of market expectations of near-term volatility conveyed by S&P 500® stock index option prices.  The CBOE Volatility Index® (VIX)® reflects a market estimate of future volatility, based on the weighted average of the implied volatilities for a wide range of strikes, first and second month expirations are used until eight days from expiration, then the second and third are used.

This material is provided for informational purposes only and should not be construed as investment advice. The views and opinions expressed above may change based on market and other conditions. There can be no assurance that developments will transpire as forecasted.

1282115.1.2


Related Articles

Low Volatility and High Uncertainty: What to Make of It?

Understanding current market conditions and what might be expected in the near term.

Trumponomics: Hope vs. Reality

Understanding potential market trends in early 2017 requires a look at the market’s recent optimism.

Even with the Dow at 20K, Risk-Mindedness Remains Important

During periods of market optimism, remaining mindful of risk is still important.