Print Friendly and PDF

China Surprise

Ouch! August is often a month of surprises. In 2011, the S&P 500 lost nearly 7% at the height of the European debt crisis (yes, it’s been going on that long). In 2013, the NASDAQ closed for three hours sending stocks into a mini tailspin. This week’s “I didn’t see that coming” was the devaluation of the Chinese renminbi by nearly 3%. China meticulously manages its exchange rate. So if it allowed the depreciation, we believe it was in response to a very real slowdown in what is now the world’s second largest economy. China’s growth depends overwhelmingly on fixed capital investment. It is equivalent to around 46% of GDP. In the U.S., by contrast, it is 16%.

But there are only so many roads, ports, airports and high-speed railways a country needs, and authorities are keen to see the export sector drive growth. Devaluation is one way to achieve a more balanced economy. The immediate effect, however, was that Emerging Market currencies fell against the dollar and markets everywhere took fright of a slowdown in global growth. One of the places we saw the fallout was Emerging Market debt spreads (i.e. how much more Emerging Market bonds yield over U.S. Treasuries). Here is the current spread, rising from around 7% a month ago to nearly 8%. Similarly, Emerging Markets equities valuations have become attractive.

China Surprise Chart

What does this mean? For now, that the U.S. dollar remains strong and Emerging Markets face slower growth. But this is also the time when discreet buying opportunities present themselves.

Bottom Line: Emerging Markets equities have had a torrid year but their Price to Book Values now trade at a 20% discount to historical averages and 35% discount to developed markets. That looks good to us.

--Brouwer & Janachowski, LLC

Please note that the discussion of the investments and investment strategy of Brouwer & Janachowski, LLC (“Advisor”) (including Advisor’s research and investment process) represent the investments and investment strategy of Advisor at the date of this commentary, and are subject to change without notice. Advisor cannot assure that the type of investments mentioned in this commentary will outperform any other investment strategy in the future, nor can it guarantee that such investments will present the best or an attractive risk-adjusted investment in the future.

Advisor cannot guarantee the accuracy or completeness of any statements or numerical data in this commentary. Past performance is no indication of future results.