For the mid-week ending August 26, 2015, the first two days of the week saw extreme panic in the markets, until Wednesday when China unleashed a new bout of stimulus. In other news: the cause of the sharp decline in the markets; the possible impact of a Fed rate hike; and, U.S. economic news remains strong.
From the close last Tuesday till the close this Tuesday, the S&P 500 lost nearly -11 percent (229 points). After the Tuesday close, China cut both the benchmark lending and deposit rates by 25 basis points to 4.6 percent and 1.75 percent respectively; and on Wednesday, China pumped 140 billion yuan ($21.8 billion) into its economy via a short-term liquidity operation. The S&P 500 rebounded on Wednesday and Thursday by 6.43 percent (120 points).
While the slowdown in China’s economy triggered the sharp decline in worldwide markets (the Shanghai Composite index reached a five-month low of 3,210.8 on Monday), there are other contributing factors: both the U.S. and UK have reported tepid economic growth; the devaluation of the yuan by China has contributed to the currency wars (where each country tries to devalue its currency to improve exports); major emerging markets, like Brazil, are experiencing recessions (the Brazilian central bank expects their economy to shrink in 2015 and 2016); and, market corrections generally occur within the period of late August through October.
Since China’s economy is the second largest worldwide, any decline will cause a drop in demand for goods and services. This is most apparent with the large drop in commodity prices, especially oil. With a 30 percent drop in the Shanghai Composite index, the Shanghai Stock Exchange halted trading and China’s central bank (PBOC) intervened. If the decline in the index continues, it is feared that it will cause a global economic collapse in 2016. Only time will tell if the policies of the PBOC can stop the fall in its markets and reverse its trend.
There has been much anticipation recently for a Fed rate hike; however, the impact of a rate hike might ironically increase the decline in longer-term interest rates. The benchmark 10-year Treasury note has actually declined from 2.3 percent at the beginning of August, to 2.0 percent currently; half the components of the CPI (consumer price index) over the last six months have declined; and, the collapse in commodity prices (oil especially), led by deflation in China’s wholesale-price level, only adds to deflation; not inflation.
Despite the global slowdown, the U.S. economy is still posting strong numbers this week. Jobless claims is down for the first time in five weeks; second quarter GDP is now expected to be 3.7 percent (up from 3.2 percent); and, durable goods orders rose 2 percent in July with business investment jumping to its highest level in 13 months. However, there are still a host of problems facing our economy, from a stronger dollar (which reduces exports) to the turbulence in China.
If you’re trading options, it is suggested trading Put and Call Credit spreads for the week at 2.5 standard deviations or greater. Expect the price of the SPX to fall within 1921 and 2024 (2 standard deviations) by this Friday.
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