China Fears and Stock Market Woes: How to See Through the Debris of the Dow

Repeat after me: The stock market sell-off in the U.S. is an opportunity. Remember this as you read on…

Barely 5 months ago China devalued its currency by 2%. The equities markets endured a near 3 week global sell-off. This wound is still fresh!

The Down was down 392 points Thursday.

Let’s look back on the Dow:

August 24, 2015 the Dow Industrial Average hit a low of 15,370.

On November 3, 2015 it was 17,977.

This movement is an opportunity!

We often think “this time is different though” and it seldom is.

Today (January 7, 2016) the People’s Bank of China lowered the daily fix for the yuan, aka renminbi, versus the U.S. dollar by 0.5%. Immediately the fear set about the world’s 2nd largest economy: How bad is the slowdown?

I expected a small devaluation from the PBOC as soon as the yuan was added to the International Monetary Fund’s reserve currency basket.

The PBOC knew a devaluation before the IMF decision could have threatened entry and reduced the percentage of yuan in the basket.

The yuan weakness is nothing new: The Chinese renminbi versus U.S. dollar daily chart shows that the current weakness is an acceleration of a trend that reorganized in late November 2015.

So why the sudden fear?

The year-end stock market rally referred to as the “Santa Rally” tops by December 21 according to a five-year seasonal chart. This historical tendency means the strength in the Dow exhausts four days before Christmas and then heads lower into and after the New Year.

Historically, these stocks bought as “window dressing” cause a mid-month decline in January.

‘Window Dressing’ — A strategy used by mutual fund and portfolio managers near the year or quarter end to improve the appearance of the portfolio/fund performance before presenting it to clients or shareholders. To window dress, the fund manager will sell stocks with large losses and purchase high flying stocks near the end of the quarter. These securities are then reported as part of the fund’s holdings. (from Investopedia.com)

Why would this year be any different?

It wouldn’t. The FOMC raising rates a quarter-point in December would already sober up buyers drunk on the low-rate punch bowl.

But, how do we account for the speed and scope of the current sell-off?

Sure, we could blame the yuan, window dressing, a North Korean hydrogen weapon test. We could also point to the Dow that spent nearly all of 2015 moving in a sideways range. It wasn’t as if U.S. stocks were in an uptrend.

The Dow reached an overbought resistance area multiple times before the current sell-off took the Dow through the November/December support.

Just like August 2015, the debris will be scary, and the dust will settle. So where will be opportunity be? Where will money be put to work?

Consider the following:

Consider that 7.6% of total U.S. exports go to China. This is less that 1% of U.S. Gross Domestic Product (GDP).

Compare that with 6.5% from Germany which is 45% of Germany’s GDP.

From 2007 to 2013 Australia was able to expand mining investments that were fed by China’s appetite for raw materials like iron ore and aluminum. 2014 was the first time demand this fell into the negative.

From 2007 to 2014 New Zealand’s dairy industry rode an uptrend until China cut milk powder imports.

The question then is who is best able to circumvent a dependence on EXPORTING into China? Exports OUT of China are so often the story and now the concern is whether an economy is too reliant on demand from China.

The U.S. is poised to benefit the most. And while it may not look or feel like it as the Dow sits a 16,463, there are stocks that are poised to rally.

The U.S. Dollar Index is hovering just above the near-term 98.00 support. It continues to trade above the 200 period simple moving average. It would reach a wide oversold support area between 97.20 and 97.00.

But there’s a catch.

Most of China’s reserves are held in U.S. Treasuries. In order to raise capital to defend the yuan, China sells U.S. dollars which really means China sells mostly U.S. 5-Year Treasury Notes. This in turn flattens the yield curve and gold benefits. As of Thursday gold futures are trading just above $1,100.

What does this mean to the U.S. market?

There are record outflows from China. Money is fleeing China at a record rate. This is easily clearing $110 billion. It’s likely more after today’s second, “circuit-breaking”, seven-percent sell-off in the Hang Seng Index. There is lot of capital looking for a home…

Next update: “FANG” stocks, crude oil, the outlook on gold and copper, commodity currencies, and how China effects the Fed. Click here to get that when it’s released.

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