For the mid-week ending January 6, 2016, the Dow and S&P 500 are sharply down as China and geopolitical events take hold. In other news: China devalues the yuan; North Korea tests hydrogen bomb; and, the FOMC minutes showed no change.
The markets dropped on Wednesday on worries about China and dropping oil prices. The Dow declined -1.5 percent (252 points), its lowest level since October 6, and the S&P 500 declined -1.3 percent (26 points). Concerns about the continuing decline in China’s economy (China initiated its first circuit breaker after its Shanghai index fell 7 percent) has sparked fear in markets worldwide. In addition, U.S. crude oil prices continue to decline (now below $34 per barrel) reaching its lowest level since December 2008.
China surprises investors by again devaluing its yuan and causing its markets to plummet. The yuan is a big risk because China’s corporations have a lot of debt, much of which is unhedged, dollar-denominated borrowing. China’s outstanding external debt was $1.53 trillion at the end of September. With the dollar rising relative to the yuan, many Chinese companies will likely default in 2016. The government recognizes that it has too much manufacturing capacity, and its devaluation of the yuan will squeeze out excess capacity.
North Korea announces a hydrogen bomb test that causes worldwide concerns and responses. Many consider this test as “a breach of the universally accepted norm against nuclear testing; a norm that has been respected by 183 countries since 1996. It is also a grave threat to international peace and security.” The verdict is still out as to the authenticity of this test since seismic readings appear to be lower than expected for a hydrogen bomb test.
The FOMC minutes released Wednesday showed all officials agreed with the rate hike; however, there is continued concern that inflation will remain below their 2 percent goal. If this continues, then it is likely additional rate hikes will be delayed this year. Investors anticipate that the Fed will raise rates two additional 25 basis points over the year to just under 1 percent by year-end.
If you’re trading options, it is suggested trading Put or Call credit spreads for the remainder of the week at 3.0 standard deviations or greater (or simply avoid trading this week). Expect the price of the SPX to fall within 1926 and 2018 (2 standard deviations) by this Friday.
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