The return of volatility

August 28, 2015

Volatility has picked up tremendously in the month of August. A major reason has been the fear created by the drastic decline in China’s domestic stock market (also known as the ‘A’ shares, listed on the Shanghai Index), as well as the concerns surrounding their policy decisions.  Although the situation in Greece remains unresolved, the impact is a small percentage to that of a China slowdown. China’s economy is approximately 43 times larger than that of Greece (based on 2014 GDP data from the World Bank).  As such, the China growth downgrade has taken the forefront of the global stage.

 

The Yuan devaluation: in mid-August, in a surprise move, China’s central bank devalued its tightly controlled currency.  The move was the largest single-day loss in the currency in 20 years.  Markets across the globe were taken by surprise.  China officials claimed the move was to bring the currency’s midpoint closer to a market-based value, however, there are many skeptics.  One thought of criticism is that a currency devaluation was made to boost company exports. In economics, and observing two countries, the country with the cheaper currency is likely to see an increase in the foreign demand for their goods.  The currency devaluation came immediately after Chinese officials announced an -8.3% drop in exports from the previous July reading.  As such, this move fueled concerns over the actual growth of China’s economy.

 

China Growth: China has long been the darling of global growth, posting strong annual economic growth numbers as high as the 14% annual growth in 2007.  However, GDP growth has been slowing for quite some time. Note the chart below courtesy of JP Morgan.

Here we can see that the tremendous growth in the Shanghai Composite of nearly 150% was not backed by fundamentals or strength in the economy.  Rather, during that period, exports and domestic demand weakened, and GDP growth declined.  As such, when the selling of China domestic shares began, it was swift and violent.  Another thing to note is that the Shanghai stock exchange is largely driven by individual retail investors, in contrast to institutional shareholders.  When these households witnessed their savings begin to evaporate, selling ensued hand over fist.

 

Portfolio Application

Historically, stocks have not increased in a straight line—there are time periods where prices decline.  Market pullbacks are fairly common.  According to Bloomberg, over the recent five-year period, we have had eight pullbacks of 5% or more on the S&P 500.  Although difficult during market sell-offs, try to maintain focus on being a long-term investor.

Source: Bloomberg

 

Further, is your portfolio 100% allocated to stocks?  Going back to a tenet of investing and proper allocation, a portfolio should match your objectives, time horizon and ability to accept risk.  As such, look at your assets in a complete picture rather than isolating your analysis on the stock allocation and day to day price quotes that stream on the popular news wires. During the aforementioned pullbacks, an allocation to non-correlated assets may have helped weather the storm.

 

Cory Nakamura CFA, CFP

Chief Investment Strategist and Financial Advisor

 

CFA Charterholder

CERTIFIED FINANCIAL PLANNER professional

Honolulu|Hawaii

 

CFA® and Chartered Financial Analyst® are registered trademarks owned by CFA Institute

 

Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, Certified Financial Planner™ and CFP® in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.

 

 

 

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