What Caused This Inauspicious Start to the New Year?

Between December 31st and January 7th the S&P 500 slid 4.93%. As we were writing our quarterly newsletter, questions started to roll in. What happened? What should I do?

To answer the first question: China happened. Last year, after Chinese economic data triggered a selloff in China that sent global markets into correction territory, China’s stock market regulator decided to introduce forced trading pauses known as “circuit breakers” to prevent another precipitous selloff. The breakers would stop trading for 15 minutes if the market fell 5% and then close the market for the day if, after the stop, the markets fell another 2%. On Monday, January 4th, the first trading day of the New Year, markets opened low and then plunged on weak economic data (China’s manufacturing purchasing managers’ index came in weaker than expected). The resulting selloff triggered both circuit breakers and closed the market 80 minutes early.

Already shaken, Chinese markets dropped again on the 6th on news that North Korea had detonated a nuclear device and that Saudi Arabia had executed the Shia cleric Nimr al-Nimr causing a diplomatic crisis between Sunni Gulf states and Iran. This led to volatility in oil prices and, therefore, the markets generally.

On Thursday, the People’s Bank of China guided the yuan downward in its largest adjustment since August. The move sought to improve the competitiveness of Chinese manufacturers in the export markets. The decision made sense; give manufacturing some help to correct the weakness seen in the manufacturing purchasing managers’ index. The markets, however, saw this as a sign of further weakness in the Chinese economy. Subsequently, the Chinese markets fell more than 7% causing the market to close after only 30 minutes of trading.

Why did this sell off in the Chinese markets result in nearly a 5% decline here? The world is starting to take notice of China’s size. Late last year, the International Monetary Fund (IMF) announced that, effective October 2016, the Chinese yuan would be added to the list of reserve currencies. This decision to add the yuan to the list of ‘elite’ currencies (British pound, U.S. dollar, E.U. euro, and Japanese yen) was an acknowledgment by the IMF of China’s economic prominence. China is the second largest economy in the world after the United States. The Chinese economy now accounts for more than 15% of global economic output. As the world begins to take notice of and react to Chinese economic data, it is no surprise that it affects our markets. For the past century, world markets have reacted to U.S. economic data in the same fashion. It is a simple fact of life: with globalization events half a world away matter.

To answer the second question: Just hang on. U.S. economic data is strong. Unemployment is at 5%. Nonfarm payrolls increased a seasonally adjusted 292,000 in December. As we have warned previously, interest rates and the transition in China will cause some volatility. However, the overall outlook is positive.