How China's Currency Move Changes the Investing Landscape

August 18th, 2015
in contributors

Money Morning Article of the Week

by Keith Fitz-Gerald, Money Morning

The markets got carried out feet first on Wednesday in early trading that saw the Dow plunge more than 230 points, the S&P 500 shed more than 25 points, and the Nasdaq crater a massive 90 points.

Follow up:

Then, as logic and common sense prevailed, the major averages fought their way back in one of the most gut-wrenching days in a long time.

There were a lot of jangled nerves out there, and China was being pilloried for its actions. But I'm convinced China's currency move was absolutely brilliant for two reasons:

  • China's doing Yellen's job for her; and,
  • China's creating a fresh round of profits for savvy investors.

Let's begin by talking about what Beijing did and why I believe this is a major move that changes the investing landscape.

This is the biggest currency adjustment Beijing's made in 20 years, and it's the biggest single drop since 1994 when China ended the old dual currency system.

On the surface, the 1.9% decrease in that nation's central bank "reference rate" is designed to support exporters and boost market pricing in China. Western analysts view it as a threat because it's clearly more "price fixing" on China's behalf.

What they don't understand is that China's been propping up the yuan for years to guard against capital outflows, to protect foreign currency borrowers, and to stabilize the yuan's role in international trade as a potential reserve currency for the International Monetary Fund. If you think China's got too much power now, imagine what the world would have looked like today if that nation had not restrained its currency.

Dropping the yuan is actually a means of making room for market-based pricing.

I've long counseled that Washington had better be careful what it wished for when they accused China of currency manipulation, specifically because of the kind of reaction that's happening today.

Contrary to what Washington would have you believe about China's currency being undervalued, the yuan's real effective exchange rate has risen by 33% over the past four quarters, according to the Bank of International Settlements. In fact, the growth was so high and so fast that it was the single fastest appreciation move and the highest among 32 major global currencies tracked as reported by Bloomberg.

Dropping the yuan is not only logical, but part of the path China has to take to make its currency fully convertible.

In the old days, China would simply set a peg rate to the dollar that - love it or hate it - was completely arbitrary. Hence the currency manipulation allegations.

But now - effective immediately - market makers who submit prices to the People's Bank of China as part of the reference rate have to take the prior day's closing spot exchange rate, foreign exchange supply and demand, AND changes in major currency rates into consideration. In other words, market-based pricing.

This is exactly what's required by the IMF for reserve status - that a currency be freely usable and market-driven.

China's Doing Yellen's Job for Her

The other thing that stands out about this move is that China is doing Yellen's job. You're not hearing about that... yet. But you will.

Classic economic theory dictates that a stronger dollar makes U.S. exports weaken, imports cheapen, devalues overseas profits, and brings about a sharp increase in domestic labor costs. By any measure, it's a restrictive economic policy, which is why the Fed has so far refused to raise rates, and - with a straight face - been able to sell their zero-interest rate policies for so long.

The problem is that sooner or later the markets always fix things themselves.

China's move immediately makes the dollar stronger. That, in turn, further hamstrings U.S. exporters and worsens the trade imbalance with China. It also shifts the competitive advantage to Beijing.

Theoretically, Team Yellen would have addressed this by shifting the advantage to the United States with a rate increase long ago. Instead, what we got was more of the same - a totally inept sequence of fiscal blunders, stimulus, and a "data-driven" Fed that's scared of its own shadow.

China simply took matters into its own hands.

Washington and New York claim they didn't see this coming and the headlines suggest it was out of the blue. Not true. In fact, China's telegraphed this move for years.

For example, Yi Gang, a deputy governor at the People's Bank of China, noted on Nov. 20, 2013, that

"it's no longer in China's favor to accumulate foreign-exchange reserves."

Zhou Xiaochuan, who was the leader of China's central bank at the time, proposed "supersovereign currency" that would diminish the importance of any national currency but especially the U.S. dollar in March 2008.

My point is that while Washington views the dollar as a weapon, China increasingly views it as a liability. And, in accordance with that nation's view of the world, Beijing has simply taken steps to defend itself.

So now what?

Despite the fact that it feels like the end of the financial universe today, that's simply not true.

Market Corrections Come and Go with Alarming Regularity

Case in point, as of 2014, market corrections of 10% or more have happened roughly once every 1.5 years or approximately every 357 trading days, according to David Bianco of Deutsche Bank. As of June 15, that figure had stretched to an unprecedented 1,350 days.

I know it doesn't feel this way, but 10% corrections are actually less common in the last 25 years than they were over the past 50 years.

The key to surviving them is maintaining perspective. If you do that, you can clearly spot the opportunities that are being served up on a silver platter rather than having to dig around in the dumpster with everybody else to find what's been thrown out.

For example:

  • China's move screams "buy" dollars.
  • Apple's suppliers just got a Christmas bonus.
  • The commodity rebound will have to wait.

Think creatively about what's going to happen... not what just happened.

Panic Is What Actually Causes You to Lose Money

That's because most investors lose their nerve when things appear hopeless and consequently wind up selling near the bottom. That's a double whammy because then they have to figure out how to get back in. I don't ever want you to be in that position.

Stick to your trailing stops. If you're using them correctly, they're like a built-in safety brake that protects your capital and helps you capture profits (like we did in the Money Map Report over the last two days on three recommendations).

Big Down Days Are the True Path to Profits

Most investors want to jump on a train that's already moving in the direction they want. That's normal because it feels good to go with the herd.

Yet, history shows very clearly that the biggest gains go to those who wade in at "times of maximum pessimism." Nobody was better at that than Sir John Templeton, who famously bought $100 of every stock trading under a buck in 1939 on the eve of WWII - some 104 companies in all. Four years and 400% later, only four didn't pan out.

Templeton would go on to found the Templeton Growth Fund in 1954 and turn every $10,000 invested then into $2 million by 1992 when he sold the fund.

Take It Slow

Crashes are funny things. The temptation is to deal with them immediately when, in reality, the best course of action is to slow down. Leave the instant stuff to the hyperactive day traders.

Crashes, corrections, slumps, dumps, train wrecks - whatever you want to call them - seldom end quickly. They have to "settle" down much like a kindergartener who's had too much sugar. What's happening now is no exception.

Your Best Course of Action Is to Let the Media Tell You When It's Over

Seriously... the dead giveaway is not that there's a crash. It's the headlines proclaiming the end of the financial universe as we know it. That's your signal. The herd is almost always wrong, which is why magazine covers, in particular, are a great contrarian indicator.

Be Ready to Buy... and Do It

We've frequently talked about the need to keep a "buy list" at the ready. What I mean by that is a list of companies and opportunities you've identified in advance for days just like today when the markets are a disaster.

The list of current Money Map Report recommendations is a good place to start. Every company on it has solid fundamentals and terrific longer-term upside that are almost completely unaffected by a short-term market correction no matter what or who causes it.

In closing, days like today are never fun. Emotions run high, and it's tough to keep your eye on the ball when every fiber in your body is screaming "run for the hills." Yet, they sure can be profitable if you know what moves to make.

Editor's Note: Money Map Chief Investment Strategist Keith Fitzgerald has uncovered six unstoppable trends - market forces so powerful that not even government meddling, reckless bank policies, or warring nations can slow them down. To access his latest investor briefing and get all his unstoppable trend research free, click here.

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