Market Perspective for August 14, 2015

The story of the week was China’s decision to allow the yuan to depreciate versus the U.S. dollar and other currencies. The People’s Bank of China said it wants to have the onshore yuan, controlled by the PBoC, trade more closely with its offshore counterpart. In recent years, offshore yuan has traded lower than onshore yuan because the market expects devaluation, though the central bank refused to allow depreciation. Opening up the currency to greater market forces serves two purposes for China at this time. First, it must take these types of steps if it wants the IMF to add the yuan to the SDR (special drawing rights) basket, making it an official reserve currency. Second, the slowing Chinese economy could use a shot in the arm, particularly from the struggling export sector.  If the Chinese central bank allows it, the recent drop in the yuan may be a small first step in what could be a much longer devaluation process.

The impact of the falling yuan was global. Asian currencies were hardest hit as they devalued in sympathy with the yuan. On Friday, the Malaysian ringgit suffered its worst one-day decline since 1998, amid the 1997-1998 Asian Currency Crisis.  Commodities were also impacted. Gold rallied on the news, but for oil this was the push needed to send it to new lows for the year.

Economic data was mixed over the past few days. Unit labor costs increased 0.5 percent in the second quarter, exceeding expectations. Retail sales were up 0.6 percent in July and last week jobless claims fell to a 4 decade low. Industrial production was solid in July, rising 0.6 percent, while producer prices climbed 0.2 percent.  The strong retail sales number caused investors to slightly increase their expectations for a September rate hike.

Greece signed a new bailout agreement but the process may have ended the current government. Support for Prime Minister Tsipras has dwindled as many in his own party rejected the bailout agreement. If the dissenters remain opposed, they are only one vote shy of toppling the government. Tsipras is expected to call a confidence vote as soon as next week.

Equities initially struggled due to China’s moves, but all of the major indexes moved into the black on Friday. The S&P 500 Index closed the week with a gain of 0.67 percent. The Dow Jones Industrial Average followed, rising 0.60 percent. The Russell 2000 advanced 0.48 percent and the Nasdaq rallied 0.09 percent.

As for sectors, even though oil prices fell, energy shares rebounded sharply and SPDR Energy (XLE) gained 3.52 percent. Behind it was utilities and industrials. Financials was the worst performing sector thanks to China’s currency move, which triggered buying of U.S. treasuries.

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