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Hold Off Your Excitement As Yuan Devaluation Sparks Stock Market Rout
By: Dr Chan Yan Chong
Articles (200) Profile

On 24 August, the global stock market went into a free-fall mode. The Dow Jones Industrial Average shed 588 points (3.6 percent) at closing after plummeting more than 1,000 points at the open. The Hang Seng Index plunged 1,158 points (5.2 percent), while the Straits Times Index (STI) fell 4.3 percent.

Everyone is saying that a stock market crash has befallen us, but has it? The STI’s high this year was set on 3 April at the 3,549-point level, while the 24 August closing of 2,843 points represented a 20 percent fall. Over the past five years, the STI has actually gone into a major correction once every year, falling between 6 percent and 24 percent each time.

However, I believe that it is still not the time to get overly excited. I recommend holding back until the stock market is truly in panic, unless you are short-selling. Do remember, though, that short-selling is only for recreational investing. I would also recommend going for call options if you are really keen, but do be prepared that you may lose all your capital.

Meltdown Not Coming So Soon

Photograph by Kyle May

A real stock market meltdown happens only once every so many years. The last time it happened was between October 2007 and October 2008, when the STI fell from 3,906 to 1,473 points, shedding some 62 percent along the way. The magnitude of the current correction as at 24 August is only 20 percent; compared to the aforementioned 62 percent loss or even the crash in 2011, this is still considered a minor correction. Remember when Buffett went on a shares buying spree in October 2008? Did he take any actions lately? Any aspiring bargain hunters would do well to keep a close watch on Buffett.

For nearly eight months, the Dow has been vacillating between 17,300 and 18,300 points, which created many opportunities to buy low and sell high. This has lured many investors to ride the waves. However, on 20 August, the Dow fell below 17,000 points and continued the plunge to 15,871 points on 24 August. Those who were betting on a rebound when the Dow was at 17,300 points are now caught out and bleeding badly. The Dow’s breach below 17,300 points is an important signal, as it had shattered an 8-months-long support level.

Devaluation of the Yuan

In recent weeks, many investors have been focusing on China, in particular the plunging Chinese yuan and A-shares. The current fall in the global stock market is actually caused by the simultaneous fall in both the Chinese and US stock markets. US investors are very concerned about whether the Federal Reserve will raise interest rates in September this year.

The sudden, sharp devaluation of the yuan has prompted many commentators to point out that this will jeopardise the Fed’s plan to raise interest rates in September. The question is whether China is influential enough, such that its move can cause the US to delay the impending rate hike.

The impact caused by the devaluation of the yuan in recent days is more severe than the stock market crash in Chinese A-shares. American politicians are clamouring for sanctions against China for its alleged manipulation of its currency exchange rate. Truth is, over the past two years, the world’s currencies have depreciated against the US dollar, with the exception of the yuan. We can go as far as to say that any appreciation of the yuan is truly due to artificial manipulation so as to patronise the US.

The Chinese government cannot afford to antagonise the US too much, so the People’s Bank of China (PBOC) came forward to explain that the yuan devaluation was due to the divergence between the onshore and offshore yuan rates. The PBOC also dismissed rumours in the market that the yuan will be devalued by 10 percent.

Eyes On Chinese Government

Source: Pixabay

Like the crash in the A-shares market, the yuan’s devaluation is the doing of the Chinese government, which scrambled to prop up the market when it realised that things were not going as planned and the market was panicking. As the yuan is currently down by only 3 percent to 4 percent, its overall impact on the Chinese economy and the stock market should be negligible. However, it appears that the Chinese government’s intervention this time did nothing to assuage the crumbling confidence of the market as compared to the previous times it stepped in to prop up the market.

In 2005, then Premier Wen Jiabao announced the reformation of the yuan exchange rate, which in essence was the appreciation of the currency. Since then, the yuan has been appreciating steadily at a comfortable, controlled rate of about 6 percent a year. Such manner of appreciation did not come about from a free-floating market, but was the result of the Chinese government’s control, which was most probably the result of a closed-door meeting between the Chinese and US leaders at that time. This explains why the yuan started fluctuating more unpredictably after Bush completed his term as president.

To date, the yuan exchange rate is still not free-floating. Its median price at the opening of the Chinese market every day is determined by the government and is traded within a narrow margin. While the announcement of the exchange rate reformation a decade ago was televised, we did not see current Premier Li Keqiang going on the television to make any official announcements this time round. We are still left in the dark on whether the devaluation is a one-off measure, a new exchange rate reform or part of a series of devaluations and thus can only continue to observe patiently.

Investors’ Takeaway

Almost all of the world’s currencies are currently down against the US dollar. Devaluation helps to improve export competitiveness and is a boon for tourism. By not devaluing, the yuan in effect appreciated against the other currencies, which is costing China its global competitiveness. Therefore, the current devaluation is actually good for the Chinese economy. This time round, the devaluation is self-imposed and not due to external attacks like in the case of the currency crisis from 1997 to 1998, since the self-devaluation is carried out on the back of a strong foreign reserves.

Warren Buffett famously said “Be fearful when others are greedy, and greedy when others are fearful.” Buffett’s success can be attributed to his control over his emotions – the winning factor behind a successful investor.

Dr Chan Yan Chong is a renowned investment expert with many accolades under his belt.

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