Stocks rally to close higher after China devalues currency

If you are not willing to own a stock for 10 years, do not even think about owning it for 10 minutes. – Warren Buffett

An unexpected Chinese currency devaluation sent shock waves through the stock market last week but stocks were able to regain their footing and finished slightly higher by Friday’s close. In a surprising move that caught many traders and investors off guard, China’s central bank devalued the yuan in order to boost slowing economic growth in that country. Economic data has been mixed in China for quite a while and many people feared that growth was weakening from the 7% level that has become the norm. In fact, China reported weaker than expected industrial production last week, confirming fears that a slowdown in economic growth was accelerating. A weaker yuan coupled with a stronger dollar would also have a negative impact on revenue growth and profits of U.S. multi-national companies and could reduce GDP growth here.  By mid-week, however, investors took comfort in remarks from Chinese authorities that refuted the claim that China would devalue its currency by as much as 10%. Investors realized, too, that the impact on U.S. growth would be small and could even postpone an inevitable interest rate hike by the Federal Reserve. The volatility in the market that resulted by the surprise Chinese announcement was also exacerbated by light trading volumes as many market participants are on vacation. Several economic reports released late in the week were positive and helped turn the market around. Both retail sales and industrial production in July rose more than expected as sales and production of automobiles surged. With China’s yuan stabilizing by week’s end and this strong economic data making a bullish case for 3^rd quarter GDP growth, investors chose to view the glass as half full rather than half empty.

Last Week

U.S. productivity rose 1.3% in the second quarter after two straight negative quarters but has averaged only 1.3% per year from 2007 to 2014. These modest productivity gains are one of the reasons for the lack of any appreciable wage growth. As mentioned above, July retail sales were stronger than expected and both May and June retail sales were revised higher. U.S. industrial production was double what had been expected as automobile production increased over 10%.

The producer price index (PPI) rose only 0.2% in July and now has fallen 0.8% over the past twelve months ended in July. Crude oil also hit the skids and sank to a six-year low of just under $42 a barrel as fears of a slowdown in China’s economy and excess supply contributed to the decline.

For the week, the Dow Jones Industrial Average added 0.6% to close at 17,477 while the S&P 500 Index gained 0.7% to close at 2,091. The Nasdaq Composite Index finished flat and closed at 5,048. 

This Week

The most anticipated event this week will be the release of the Federal Reserve minutes from its July meeting as investors will look for clues about the timing of an interest rate hike based on labor market improvement and inflation data. The July consumer price index (CPI) is expected to rise modestly indicating that inflation is still benign. Existing home sales for July are forecast to weaken slightly from strong levels in June and July while housing starts should increase as building permits show big gains.

Retailers will dominate this week’s earnings calendar as Home Depot, Lowe’s, Wal Mart Stores, Target, TJX Companies, Dick’s Sporting Goods and Staples are all scheduled to report. Other notable companies on the list include Hewlett Packard and Deere & Co.

Portfolio Strategy

While the Chinese currency devaluation last week raised fears that U.S. economic growth might be affected, much of the recent data suggest that the economy is actually gaining strength. The Institute for Supply Management (ISM) index that measures economic activity in the nonmanufacturing sector rose to a 10-year high in July and was much better than expected. This is encouraging because it covers a much larger part of the U.S. economy. Automobile sales also were strong in July and came close to setting a 10-year high. Over the past three months, the labor market has posted average job gains of 235,000, most of which were in the private sector. With last week’s stronger than expected retail sales and industrial production data, it’s likely that second quarter GDP will be revised higher from the initial reading of 2.3%. Consumer spending accounts for almost 70% of all economic activity and recent strength in the retail sales data bodes well for future growth. The Small Business Optimism Index reported last week was also strong and did nothing to detract from this sanguine view. Everyone knows that the Federal Reserve wants to normalize monetary policy and begin to raise interest rates as soon as the economic data make it possible. It looks more and more like they may be given this opportunity in September.