The Participant 8/12/15: China’s Devaluation

by Jason Kelly

Wednesday, August 12, 2015



China’s currency devaluation is being presented as a critically important story, even more important than if and when the Federal Reserve will raise interest rates. Yet, the yuan was devalued by only 2%. Those most concerned about this say deflation will cascade out in ripples from Shanghai, taking down other Asian currencies, making imports into the United States cheaper and therefore hurting the profit margins of public companies in the US and suddenly making their stocks look too expensive. In that fashion, this could finally be what does in the bull market, they say.

China probably wouldn’t mind a boost in its export volume, given that it fell more than 8% last month, but is a 2% currency devaluation large enough to make a dent in the damage? Probably not. What, then, is China doing? The same thing it does militarily around Asia every month. It probes the level of resistance its neighbors put up when it questions their borders and ocean rights. When one doesn’t push back convincingly enough, China sets up an outpost that never gets moved. Inch by inch, it’s expanding its influence around its home continent without ever setting off red alerts. In the currency arena, it appears to be up to the same business. It’s sending off a signal without setting off alarms.

What signal? One that says it’s a mature economy capable of managing its currency in a manner flexible enough to earn a place in the world’s reserve currency basket. That would be the IMF’s special drawing rights (SDR) basket which, by no coincidence, China has been trying to get into for the past five years. Just last week the IMF balked again, and just this week China made a wee adjustment to the value of its currency, enough to show it can do so but not enough to bring the ire of Japan, the US, and Europe. Incrementalism is the Chinese way.

On top of that, China’s forex reserves recently began declining after more than a decade of rising. Capital outflows are one way for the currency market to show a country it thinks the currency is too strong. In this case, it makes sense. China is not a boomtown any more, it’s just a place growing more quickly than other places. The yuan needed to fall in value to a level more commensurate with what currency traders think it should be, which would stabilize capital movement. Taking care of this helps China in three ways: It sends that aforementioned signal to the IMF, it provides a small boost to China’s export market, and it adjusts the value of the currency to better reflect slower growth.



From Note 28 sent to subscribers last Sunday morning, with data as of Friday, August 7:

Economist Christopher Baldy at Peking University tallied the bailout and stimulus measures enacted by China since its June market crash, and came up with $1.3T — more than 10% of GDP. By comparison, America’s Troubled Asset Relief Program (TARP) was originally set at just $700B and targeted a systemic financial crisis in an economy about 70% larger than China’s. The overreaction to a market bubble created by uneducated traders could be part of the reason the global financial community considers China to be an immature participant.

From West Texas Intermediate crude oil at $59.13 and our own Oil -2x (DTO $106.20) at $65.72 in Note 21 sent June 7, we’re now at WTI $44 and DTO $106. Should the recent trend continue, WTI will reach $40 and DTO will hit our $120 exit price soon. On Thursday, DTO achieved a triple-top breakout, assigning itself a new P&F bullish price target of $128. Great!

Barron’s is pushing the oil sector. Its cover story this weekend is “Commodities: Time to Buy” and writer Andrew Bary advises, “While calling a bottom is dangerous, we think it’s prudent to start adding commodities to your core portfolio at these prices.” Like all commentators, Barron’s is sometimes right and sometimes wrong. Its February 16 article “Big Oil Stocks Are Still Too Pricey” was right. Its November 3 article “Commodities: Buy When the World Is Selling” and its December 22 article “Five Oil Stocks to Buy Now” were wrong.

See if you can detect a pattern across the past four weeks:

Week Ending 7/17: S&P 500 at 2127 (+2.4%) produces bullish commentary
Week Ending 7/24: S&P 500 at 2080 ( -2.2%) produces bearish commentary
Week Ending 7/31: S&P 500 at 2105 (+1.2%) produces bullish commentary
Week Ending 8/7: S&P 500 at 2078 ( -1.2%) produces bearish commentary

A preliminary scientific analysis suggests commentary gets bullish after prices rise, and bearish after they fall. The four-week time period began with the S&P 500 at 2077 on July 10 and ended with it at 2078 on August 7, a net change of zero. During this time of no change, the best way to have made money would have been to sell the bullish commentary and buy the bearish, but it’s hard to do when the weight of opinion is against you, which is why we rely on the signal system to tell us when prices are down (and bears are loud) and should be bought, and when they’re up (and bulls are loud) and should be sold.

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The following forecast is from David Stockman’s appearance on CNBC last Friday.

David Stockman has long warned that the stock market is on the verge of a massive collapse, and the recent price action has him even more convinced than ever that the bottom is about to fall out.

“I think it’s pretty obvious that the top is in,” the Reagan administration’s OMB director said Thursday … [He] still believes that the excessive monetary policy from central banks around the world has created a “debt supernova,” and all the signs point to “the end of the central bank enabled bubble,” which could cause a worldwide recession. …

“[T]he world economy, including the US, is heading into what is clearly going to be an epochal deflation to the likes of what we have never experienced in modern time. … The whole global economy since 2008 has been driven forward by this massive investment and construction and borrowing spree in China. The point that I’m making is that it’s over. … the central bank-driven credit economy is over and we are in a new era. It’s a huge disaster waiting to happen.”

To see this call in The Z-val Zone, please visit:

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Background: The term “z-val” is a shorthand introduced in the book, “The 3% Signal,” for “zero-validity forecasters” and “zero-validity environment.” The latter phrase was coined by Nobel Prize winner Daniel Kahneman in his book, “Thinking, Fast and Slow,” where he wrote that “stock pickers and political scientists who make long-term forecasts operate in a zero-validity environment. Their failures reflect the basic unpredictability of the events that they try to forecast.” This is why stock market forecasters are proven to sport an accuracy rate of about 50%, same as a coin toss, yet they continue forecasting.

You can peruse the growing collection of tracked forecasts in The Z-val Zone at:

Seen a forecast I should track? Send me the link in a reply to this note.



Smart friends have been looking askance at what they call the misplaced obsession with Donald Trump in the early phase of the GOP’s run for the presidency next year. I’m not sure it’s misplaced. I don’t believe Trump will become president, but I do believe the attention to him reveals desperation for honest political talk in a world where politically-correct sawdust obscures the view.

Last week’s debate in Cleveland achieved an overnight Nielsen rating higher than the last game of the NBA Finals. What’s everybody so interested in? Trump. It’s all Trump. The other stiffs at lecterns were just space holders parroting the same poll-tested talking points in the same dry, made-for-the-bell-curve vocabulary that means nothing. Dave Pell at NextDraft wrote, “The way I see it, Trump is bombastic, wrong-headed and offensive, but our obsession with him is worth noting, if only because ‘normal’ political discourse has become so scripted and disingenuous that Trump actually comes off as weirdly refreshing (to everyone other than Rosie O’Donnell).”

For my money, Walter Russell Mead at The American Interest put his finger on it: “For voters who’ve come to believe that both parties are owned and operated by the kind of people who pay Hillary Clinton hundreds of thousands of dollars to make platitudinous speeches, who believe that the system is rigged and will never be reformed … Trump at least offers the satisfaction of making the other rat bastards and pompous PC elites squirm. … Trump offers average Americans the chance to pull the Establishment’s chain, and then watch the wonks and the pundits jerk and squeal. This is a lot of fun for the tens of millions of people out there who think the whole political class consists of high-minded incompetents and unprincipled parasites.”

Yours very truly,
Jason Kelly

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