Stock Report For Week Ended August 21, 2015
Stocks fall sharply on worries about China-led slowdown
The major benchmarks experienced their largest weekly declines since 2011 as worries grew that China's economic slowdown would weigh heavily on global growth and commodity prices. A plunge in some emerging markets currencies also raised fears of a global round of competitive devaluations, which would drag further on the profits and competitiveness of U.S. multinationals. All of the benchmarks moved into negative territory for the year to date. By the end of the week, the Dow Jones Industrial Average and the small-cap Russell 2000 Index had declined by more than 10% from their highs, putting them in what is commonly considered correction territory.
There are worries that China's devaluation will start a trend
U.S. stocks experienced most of their selling pressure at the end of the week. Several factors appeared to be driving the selling, although most were traceable back to China's decision the previous week to devalue its currency by loosening its peg to the U.S. dollar. Fears grew that China's move reflected a steeper slowdown in the country's once-rapid growth than previously acknowledged—concerns that deepened on Friday, following news that Chinese factories were operating at their slowest pace since the financial crisis of 2008—2009. Steep drops in other emerging markets currencies also weighed on sentiment. The tenge, the currency of Russia's southern neighbor Kazakhstan, tumbled precipitously after it removed its dollar peg entirely, but the floating currencies of other nations fell as well.
...but T. Rowe Price experts note that more positive forces are also at work
T. Rowe Price managers and analysts have been following the developments in China closely, from both equity and fixed income perspectives. Equity Portfolio Manager Eric Moffett, based in the firm's Hong Kong office, observes that China's devaluation move has been at least partly in response to pressure from the International Monetary Fund and other global bodies to allow the country's currency to float freely. He also notes that China's currency has devalued only modestly relative to the dollar and on par with other Asian currencies, meaning that it has not gained much in the way of improved competitiveness. For these reasons, he believes it is unlikely that China is embarking on some sort of currency war, which its leaders know is unwinnable.
Drop in commodity prices may be more durable and profound
The week's other major global financial disruption came from the ongoing drop in oil prices, which reached six-year lows. The drop appeared to be partly in response to the slowdown in Chinese demand, but supply concerns also took a toll. Stockpiles of U.S. crude continued to rise, leading to some concerns that major storage facilities would soon run out of room. Meanwhile, Saudi Arabian production topped the peak it had established in 1980, and traders braced themselves for the arrival of significant new supplies from Iran once sanctions are lifted. Prices for other commodities, such as copper, followed oil lower, weighing heavily on the materials sector. T. Rowe Price analysts and portfolio managers believe that the global economy has entered a long-term cycle of declining commodity prices that will be exacerbated by declining production costs.
Upside of falling commodity prices seen in data but fails to reverse sentiment
The upside of lower energy and commodity prices for consumers was also evident during the week, although it appeared to provide little comfort to investors. Economists have been looking for lower gasoline prices to stimulate spending, and several prominent retailers reported better-than-expected earnings. The trend was particularly pronounced among building supply stores, which are also benefiting from continued strengthening in the housing sector. Reports showed July sales of both new and existing homes reaching their highest pace in eight years in July. T. Rowe Price Chief U.S. Economist Alan Levenson thinks that the improving job market and demographic trends are resulting in a higher level of household formation, which should continue to provide support for the housing market.
Fed uncertainty adds to worries
Another source of volatility for the market during the week was the deepening uncertainty over when the Federal Reserve will begin to raise interest rates. Mr. Levenson and many other economists agreed that the darkening global economic backdrop increased the possibility that the Fed will wait past its next meeting in September to begin raising rates. The minutes from the Fed's July policy meeting also appeared to give temporary relief to markets after their release on Wednesday, as they indicated that policymakers remained concerned about the low level of inflation. Mr. Levenson expects that continued improvement in the labor market will be the decisive factor in the first rate hike, however.