Global markets are paralyzed with shock this morning following a disastrous, shortened day of trading in the Chinese markets overnight. Quickly after opening, the Chinese stock market was halted as its newly minted circuit breakers were triggered following a 5% widespread selloff. Shortly after the 15-minute delay in trading (as are the rules of the circuit breakers) and reopening, panic continued to sweep across the Chinese investing community, moving equities down 7% for the day and forcing the closure of the market for the day after only 30 minutes of trading.
The resulting volatility has spread to our own markets, with the Dow Jones Industrial Average and S&P 500 down roughly 190 points and 1.2%, respectively, at the time of this publication.
We have been repeatedly bearish on both the market as a whole and in particular the energy market yet are beginning to see value in a handful of names. Our large cash position allows us to opportunistically pick at names that we believe have been oversold and demonstrate characteristics (strong balance sheets, diversified portfolios, and robust free cash flow generation/capital returns) that are defensible in today's volatile market environment.
The selloff in the world's second largest economy was driven by the Chinese government's surprisingly weak valuation of the yuan, which fell 0.5% below Wednesday's levels (among the biggest day/day variation in the country's history). Making matter worse, there is a strong sense across the globe that Chinese regulators don't know how to properly manage the markets. While the installation of circuit breakers was done with the right intentions, the rules behind them do not truly allow the market to trade in a free fashion -- while stopping a selloff is all well and good, quickly closing the markets only creates a vicious, escalating cycle of panic. In fact, and likely in light of these reasons, the Chinese government just announced its decision to suspend circuit breakers for the foreseeable future.
Unfortunately, the fears about the strength of the Chinese economy and expectations for continued currency devaluations (and possible cross-border currency wars) have spread to commodity markets as oil continues its slide. Concerns are mounting about future demand for crude in China, which is the world's second largest consumer of crude, may not be able to support the already oversupply of the commodity across the globe. This has only clouded the outlook for oil even further, as the trade is also being pressured by tensions in the Middle East -- where major oil producers continue to pump at high levels to gain market share -- by expectations for Iran's oil to enter the market, and by U.S. production, which has fallen much slower than expected.
We made it clear in our late afternoon Alert Wednesday that we will not consider trading into the energy collapse until the convergence of geopolitical, macroeconomic and supply/demand headwinds have stabilized.
Adding insult to injury in the U.S. is that the Fed seems intent on remaining on its tightening path, which, while likely gradual, may prove to be premature given the escalating global macroeconomic and geopolitical instability. The labor market seems to be the only true pocket of sustained strength in the U.S. economy, but this is unfortunately a lagging indicator rather than a forward-looking one. The Fed's reliance on a strengthening job market as the primary basis for its monetary policy decisions fails to take into account the severe, persistently low levels of inflation.
All in all, we are not surprised by the steep global selloff this morning and remain skeptical on the markets given the hand being dealt. That being said, we are pleased to have a large cash balance on hand to not only protect the portfolio but also to allow us to opportunistically add to our favorites at depressed levels. While we ultimately believe the negative sentiment will pass, we expect increased volatility in the near term as China and oil continue to be irrevocably linked to our broader markets.
In particular, we would consider being buyers of Bank of America (BAC) under $16, Stanley Black & Decker (SWK) under $100, Walgreens Boots Alliance (WBA) under $80 (we are currently restricted on the name), Wells Fargo (WFC) under $50 and WhiteWave Foods (WWAV) under $37.
Note: Subsequent to this posting to Action Alerts PLUS subscribers, the portfolio added to positions in Bank of America and Stanley Black & Decker as both names declined below the levels noted above.