The Volatility Continues
The volatility continues... A 'round trip' in U.S. stocks... China falls to new lows... Keep an eye on the yuan...
The volatile week in U.S. stocks continued today...
The broad markets started the week with a small decline. On Tuesday, they exploded higher for their biggest single-day gain in months. Yesterday, stocks started the day in the red – at one point giving back more than half of the previous day's rally – before closing slightly higher. And today, they opened sharply lower again and continued to decline throughout the day.
All told, stocks have gone nowhere this week. As we write, the markets are virtually unchanged since last week's close.
Regular readers know we expect this to continue...
We've spent a lot of time this month showing you why we remain cautiously bullish on stocks today.
In short, all of the most important long-term measures of market and economic health tell us the risk of a true bear market or recession are remote. And following last week's big sell-off, several reliable short- and intermediate-term indicators tell us stocks are likely to trade significantly higher in the months ahead.
Of course, none of this means we can't see more downside in the meantime. As we've discussed, the broad market could easily fall another 10% or more in the midst of a normal correction.
In fact, we've already seen this play out several times since the bull market began in 2009, including most recently in late 2015/early 2016 (more on this in a moment). There's no reason we couldn't see something similar today.
But again, no matter what happens next – whether the sell-off continues or the "Melt Up" resumes immediately – you absolutely must be prepared for more volatility in the months ahead.
We're likely to see additional corrections – and plenty of wild swings – as the final "inning" of this bull market plays out.
Outside of the U.S., today's biggest news came from China...
The country's benchmark Shanghai Composite Index plunged 3% to just shy of a fresh four-year low. Chinese stocks – which were already the world's worst-performing so this year – have now lost roughly 30% of their value since January.
Today's stock market sell-off followed a steep decline in China's currency, the yuan, after the U.S. Treasury Department criticized the country's currency "practices" last night. As the Wall Street Journal reported...
The U.S. Treasury again passed up a formal opportunity to designate China a "currency manipulator," but singled out the nation's currency practices as a source of "particular concern."
Treasury Secretary Steven Mnuchin faulted China's "lack of currency transparency and the recent weakness in its currency," saying in a statement that this poses "major challenges to achieving fairer and more balance trade, and we will continue to monitor and review China's currency practices."
Though it passed on calling China a manipulator, the Treasury kept China and five other nations on a formal "monitoring list," in its semiannual report on foreign-exchange policies of major U.S. trading partners. The report is the official vehicle for making a declaration that a country has manipulated its currency to obtain an unfair trading advantage.
The yuan fell to nearly 6.95 per U.S. dollar today, its weakest level in nearly two years, and dangerously close to record lows.
Earlier, we mentioned the correction of late 2015...
Longtime readers may recall that much of the turmoil in global markets back then was initially blamed on the steep and sudden decline in the yuan.
Back then, the Chinese government unexpectedly devalued the yuan to remain competitive with other emerging market currencies that had been plunging for nearly a year. Today, it's almost certainly a result of the ongoing "trade war" with the U.S.
However, we couldn't help but notice that China's government didn't begin to devalue the yuan in earnest until Chinese stocks had fallen roughly 30% from their peak... which is exactly how far Chinese stocks have fallen this year.
Of course, we have no idea what China's government intends to do next...
But the recent decline in the yuan is worth watching. It suggests the Chinese government is becoming worried about its economy and may now believe the potential benefits of devaluing the yuan outweigh the risks.
Regardless, if the yuan weakens further – particularly if the decline begins to accelerate – we could see the bear market in Chinese stocks continue. And if the losses become severe enough, it could lead to volatility in markets outside of China, like we saw back in 2015.
There are two important takeaways here...
First, this is exactly why Steve Sjuggerud has been adamant about waiting for the uptrend to return before getting back into Chinese stocks. As we've seen in recent years, these stocks can boom and bust more than you might believe possible.
For example, during the last bust in 2015-2016, one of Steve's favorite China funds fell more than 50% in just eight months. Even after today's new lows, this fund has fallen "only" 35%. There could be further downside ahead.
So while he remains incredibly bullish on China for the long term, he isn't ready to recommend buying back in just yet.
Second, further selling in China could easily lead to a continued sell-off in the U.S. as well. But again, these concerns didn't spell the end the bull market back in 2015... and we don't expect them to today.
Stay long... stay smart... and keep a close eye on your trailing stops, just in case.
New 52-week highs (as of 10/17/18): none.
Well, it appears many Digest readers are still leaning bullish today. How about you? Let us know at feedback@stansberryresearch.com.
"I am still bullish for the moment." – Paid-up subscriber Jim B.
"Bullish." – Paid-up subscriber Philip M.
"Bullish." – Paid-up subscriber Linda O.
"Bullish! After the big sudden drop, I took last Friday October 12 as a buying opportunity. I reviewed the current buy recommendations in the Extreme Value and Retirement Millionaire portfolios and I purchased several stocks at steeply discounted values. It felt right to pull the trigger and reading today's Digest reaffirms my actions. Thanks." – Paid-up subscriber Matt W.
Regards,
Justin Brill
Baltimore, Maryland
October 18, 2018