As is usually the case, several catalysts came together at the same time to produce an unsurprising stock market sell-off. These included: comments from the Federal Reserve regarding quantitative easing, rising 10-year Treasury yields, weak earnings from benchmarks, and concern over China’s real estate market and its banks.
While China’s stock market has been in a pronounced downtrend since the first week in June, its banks are still controlled by the government, so any potential banking crisis in that country is a different game than we’ve seen before because of China’s $3.3 trillion in foreign currency reserves (mostly in U.S. Treasuries).
But that very game could have serious consequences for the U.S. stock market if China needed that money to flood its capital markets with liquidity. With a different approach to saving, money creation, and fiscal management in general, currency destabilization from China is an ongoing risk.
It was just a few years ago that capital markets treated economic news from China as emerging market news only. Now, China’s economic news is taken very seriously by the global economy, and the country’s numbers directly affect the U.S. stock market.
It’s just one more reason to be very conservative with your equity holdings now. Investment risk across all financial asset classes is high.
One thing that China and many of its U.S.-listed companies have proven is that they’re unreliable with their numbers. After countless missteps with U.S. regulators and outright frauds on the stock market, the biggest Ponzi scheme the world has ever seen might not be the U.S. monetary policy, but rather China’s domestic banking system.
It’s a growing investment risk for all financial assets. Because China is not an open economy, we just can’t quantify the degree to which the world is at risk due to its management. The entire “Red Dragon” (forecast to be larger than the U.S. economy by 2016) is a powder keg of ambiguity.
It’s just one of the many reasons why I’m an advocate for keeping retirement stock market holdings as blue-chip and domestic as possible. Financial control for U.S. investors continues to be on the decline.
Both Treasuries and the U.S. stock market have been due for a major correction for some time. On the cusp of a new earnings season, more stock market weakness is likely. I don’t expect corporate earnings to surprise to the upside.
There should be no doubt that China’s domestic economic situation directly affects U.S. capital markets and now the stock market.
Recent trading action in all asset classes illustrates the degree to which all investors are vulnerable in a supercharged monetary world. Reliability of data, processes, the regulatory environment, market participants, and cash itself is untenable. (See “Crash, Down Quarter, Major Correction—It’s All in the Cards.”)
For investors, only the safest names will do. Generally speaking, I still feel the stock market isn’t worth buying after its big run-up.
More China-related turmoil in capital markets is highly likely in the near term.