Week of August 17, 2015

Volatility returned to the markets last week when the Chinese central bank devalued its currency and enacted policies toward a more market-based exchange rate. Investors were already on edge about slowing economic growth after watching the plunge in oil, gold, industrial metals and the Chinese stock market. Despite its wild price gyrations, the S&P 500 squeezed out a gain for the week, rising 0.67%. 

While the S&P 500 remains positive for the year, much of this is due to the strong performance of a select number of stocks. There is much more turmoil when looking beneath the surface as more than half of S&P 500 stocks are in correction mode (10%-plus decline) and the Dow Jones Industrial Average is off nearly 5% from its peak.

China Surprises With Currency Devaluation

Early last week China’s Central Bank shocked investors by devaluing its currency to create the yuan’s biggest one-day loss since 1994 when its value fell by one-third. It continued depreciating throughout the week. The yuan had been on a steady march higher versus the dollar over the past decade as the Chinese economy grew to become the world’s second largest and the government exhibited a heavy hand controlling its value. Technically, the yuan was allowed to move within a 2% band, but many times China’s central bank ignored the market and set rates where it wanted. Part of the devaluation is to move toward more market-driven pricing to appease the IMF. China wants the yuan to be considered a reserve currency like the U.S. dollar, the euro and the Japanese yen. The move should also help with exports that recently posted a contraction of 8.3% for July, far worse than the anticipated 1% dip. It will also affect several Chinese companies who hold more than $525 billion of dollar denominated debt. In one fell swoop this move pushed their debt costs $10 billion higher.

^{Source: http://www.wsj.com/articles/china-moves-to-devalue-the-yuan-1439258401}

Merger Mania Returns

Warren Buffet made waves last week with the titanic acquisition of Precision Castparts, the Portland Oregon aerospace supplier. This $32 billion transaction was the largest in Berkshire Hathaway’s 50-year history, and just one of many announced so far this year in what could become a record-setting buying spree in 2015. According to Dealogic, activity for 2015 is on pace to reach nearly $4.6 trillion and surpass the previous peak witnessed in 2007. Several conditions are creating a prime environment for deal making. After years of cost cutting, managers are now searching for ways to boost profit growth as the economy remains sluggish and top-line growth stalls while the cost of borrowing remains low. However, the ideal conditions don’t ensure a record breaking year. In 2007, the pace of deals during the first half of the year was on track to exceed $3 trillion. Volume collapsed in the back half of the year once credit seized up following the housing collapse.

^{Source: http://www.wsj.com/articles/m-a-deal-activity-on-pace-for-record-year-1439249011}

OPEC Keeps Pumping

The recent pullback in oil prices is testing the unity of the Organization of the Petroleum Exporting Countries (OPEC), the 12-nation cartel. Last week, the organization released its monthly report that showed its members pumped 31.5 million barrels a day in July. This is the highest level of production since May 2012 and more than 1.5 million barrels above the cartels target. Historically, OPEC has adjusted output to support prices, but during the most recent downturn it has emphasized protecting market share. This stems from the U.S. shale boom. Domestic production remains near all-time highs given many projects can still be profitable at prices below $40 a barrel. The stubbornly low oil price is beginning to cause a strain on OPEC members. Libya and Algeria have already called for an emergency meeting to reverse the decision to maintain production. This request was rejected by Saudi Arabia, Kuwait, and the UAE who carry more weight in the cartel.

Fun Story of the Week

The farm-to-table movement took one small step for man and one giant leap for mankind last week when Japanese astronaut Kimiya Yui and NASA’s Scott Kelly feasted on a salad prepared with romaine lettuce grown on the International Space Station. NASA has long been interested in how to grow food in space for long-haul missions to far off places like Mars. Veggies have a long history in space, but this was the first “official” meal eaten by a U.S. astronaut. In 2014, lettuce was grown but flown back to earth for lab tests. Before that, in 2002 Russian cosmonauts harvested and ate vegetables grown on the Space Station, but NASA astronauts didn’t join the feast. It is widely speculated that they unofficially snuck a taste though.

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