Investors have a right to be nervous right now. Stocks have gotten off to one of the worst starts to an investing year in the market’s history. The Nasdaq just posted its lowest close since October of 2014, which, not coincidentally I presume, was when the Federal Reserve ended the last of its three large quantitative easing programs that quintupled its balance sheet to over $4 trillion. Some sectors of the market like small caps, energy, biotechs, transports, and the like make the decline in the larger indices look like a walk in the park at this point.
There has been a litany of worries that have driven equities down across the board particularly in the high-beta sectors the market. Among these are the continued collapse of oil and commodities, anemic global demand, a greenback that continues to strengthen and a spike in volatility in the high-yield credit market. Of course, investors also have immense concerns about both the slowdown in the Chinese economy as well as the huge volatility in its domestic stock market.
There is also another trend that is just starting to get some mention coming from the Middle Kingdom. Unfortunately, it is something that looks like it will lead to further turmoil emanating from China in the not too distant future. It has an increasing potential of roiling the global currency and equity markets. As such, investors should have it as one of their primary “watch outs†for the market and be very aware of this event’s possible impacts.
There was a massive drop in the country’s FX reserves in 2015 which accelerated towards the back end of the year and has continued in January. In 2015, some $500 billion of reserves vanished across China. This is the first time this has happened on an annual basis in a generation.
There are many reasons for this. The first is the country is trying to maintain the value of its currency, the Yuan, to lessen capital leaving China. The second is Chinese companies have been converting their dollar-based debt to Yuan denominated as they fear their currency will depreciate against the dollar decreasing their ability to pay back their debt. Finally, we have the unintended consequences of Chinese authorities making a big push to crack down on corruption even at highest ranks under its new leadership. This has driven billions and billions of assets overseas to such locations as London, Switzerland, and New York. Corruption has been rampant in China for decades. As an example, a former defense minister had managed to acquire a fortune estimated at some $14 billion before he was recently targeted by authorities in their crackdown.
