China: Expect Short-Term Volatility to Continue

January 7, 2016

For the second time since the new year, trading was halted in China after the stock markets fell 7% on January 7, sending ripple effects around the world.

What’s fueling the sell-off?

We see this as a crisis of confidence in Chinese policy makers and regulators. There’s a lot of uncertainty around how the currency is being managed and how the policy makers and regulators are intervening in the stock market.

Starting January 8, the China Securities Regulatory Commission is suspending the circuit-breaker rule, which halts trading for the day if the stock market falls by 7%.

What’s happening with the currency?

China has traditionally pegged its currency to the U.S. dollar. However in August 2015, it changed its method by basing the exchange rate on the yuan’s previous closing and taking into account the yuan’s supply/demand as well as the valuation of other currencies.

With the yuan beginning to weaken in late December 2015, the People’s Bank of China announced on January 7 that it would set a lower daily fixing of 6.5646 against the U.S. dollar. The decision to establish a market-driven exchange rate system is beneficial, but it also raises concern over the policy makers’ commitment to backstop the currency’s depreciation.

These actions created a panic in the markets since investors and companies with assets and revenues valued in the yuan tried to hedge currency risk in a market that’s not very liquid.

What happens next?

Over the past six months, such policy uncertainties have had a significant impact on global markets. For instance, following the yuan’s 3% devaluation announced on August 11, 2015, the MSCI All-Country World Index lost 8.9% (Canadian dollar terms) in two weeks. It also had an impact on policy makers in the developed world.

As China actively tweaks the way it intervenes in the market, it could lead to more volatility going forward and potentially spill over into global markets as investors react to Chinese market events.

What is MD doing about this?

Our outlook has not changed on the markets as a result of the volatility stemming from China. We are not making any immediate changes to our portfolio strategy although we continue to monitor the situation closely.

MD portfolios are designed to be well diversified, such that they handle this type of short-term uncertainty while still delivering strong long-term results consistent with investor goals and time horizons.

MD funds and pools are actively managed, which means that changes are continuously being made in anticipation of, or in response to, a wide array of events and market changes. In some MD funds the current market pullback is viewed as a buying opportunity to acquire attractive stocks at reduced prices, while in other funds the downturn is viewed as confirmation of an already defensive posture. In all cases the impact is being assessed and acted upon in a prudent fashion for the intent of the fund or pool.

We encourage you to contact your MD Advisor if you have any questions. For more information, please review Chinese Stock Market's Latest Moves.

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