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Trade war reignites over China currency, spooking Aussie markets

Emma Rapaport with AAP  |  07 Aug 2019Text size  Decrease  Increase  |  
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Australia's share market plunged yesterday after a fall in the Chinese currency reignited the trade war between the US and Beijing and sparked concerns over the global economy.

US President Donald Trump has labelled China a “currency manipulator” for allowing the yuan to sink below 7 against the dollar, a decade low, raising the prospect of a currency war between the two nations.

While most global currencies are floating - determined by market forces - the Chinese government limits the yuan’s movement against the US dollar to a daily range of 2 per cent. But a cheaper yuan makes its exports more competitive, especially as China battles to control the effect of trade tariffs imposed by the US. However, it also makes imports into China more expensive and puts a strain on the domestic economy, potentially pushing inflation up.

The Dow Jones fell almost 3 per cent to 25,700 amid fears of the effects of a ramping up in the trade war. Meanwhile, the FTSE 100 is down from 7,600 points to 7,200 points in a matter of days. China’s Shanghai Composite Index has fallen around 6 per cent to 2,700 points in the first week of August, signalling a retreat from emerging markets. Shares in emerging markets-focused investment trusts have also fallen sharply.

The benchmark S&P/ASX200 index was down 162.3 points, or 2.44 per cent, to 6,478 points at midday on Tuesday, while the broader All Ordinaries was down 166.9 points, or 2.49 per cent, to 6,543.7 points.

Global markets | 10:15AM 6 August 2019

Global market performance

Source: Morningstar

The news comes a week after the ASX200 finally beat its record high set nearly 12 years ago, propelled higher to the tune of a dovish symphony from central banks around the globe.

"There's blood on the streets of the financial markets this morning and with both the US and China seeming to be taking a harder line as each session passes, there could be even more downside to come for investors,".

"Only time will tell if this is another dip in the relentless grind higher that we've seen so far in 2019" or the start of a bigger sell-off, said Xchainge founder Nick Twidale said in an analyst note, adding that to many this "feels a lot different" than earlier market volatility.

Eleanor Creagh, markets strategist at Saxo Capital Markets Australia says the latest trade war escalation has served as a reminder that stocks were priced for perfection, and deaf to the omnipresent risks lurking on the horizon, with valuations stretched relative to historical averages leaving very little margin for error.

"On that basis risk sentiment will remain fragile, equities can correct further, and bond yields will continue their fall. Thus, an element of caution is warranted in asset allocation decisions with defensive positioning and a focus on capital preservation likely to be rewarded," she says.

Tit-for-tat devaluation

George Efstathopoulos, multi-asset portfolio manager at Fidelity International, says a US intervention to weaken the dollar cannot be ruled out, particularly with Trump a vocal critic of the strong US dollar: “The chance of getting his way is surely higher now the Treasury has labelled China a currency manipulator and because the same department also has responsibility for setting US dollar policy.”

He believes the prospect of a US-China currency war has become more likely and this will lead to increased demand for safe havens such as the Japanese yen, gold and even the euro. Bitcoin prices have spiked in recent days too.

When trade war concerns peaked late last, Morningstar Investment Management’s Dan Kemp urged investors to tune out from the “noise” of volatile markets if they want to achieve their long-term goals: “When prices fall, we are typically far more focused on the loss to our existing capital than the opportunities to buy assets more cheaply.”

Don't give in to fear as markets fall, 6 November 2018

Dan Kemp is Chief Investment Officer, Morningstar Investment Management EMEA

Fidelity's Efstathopoulos adds that China is likely to respond in kind to any US attempts to weaken its currency. The Chinese move to weaken the yuan was probably a deliberate response to the latest US tariffs on Chinese goods, argues Andy Rothman, investment strategist at Matthews Asia.

But China is unlikely to embark on full-scale devaluation, he argues as the latest tariffs are not having much of an impact on the Chinese economy: “China’s consumer story—the largest part of its economy—remains pretty healthy, as does employment and wage growth, so there is no reason for Xi Jinping to panic.”

Kerstin Braun, president of trade finance firm Stenn, argues that “Trump is playing games with global economies”. She says: "He lives and dies by the markets, and there’s a real worry Trump will try to tank the dollar in retaliation."

Tech stocks take a beating

Tech and health care shares were among the worst hit, slumping 4.78 per cent and 3.78 per cent respectively, but every sector except mining was down more than one per cent.
Creagh says stocks like Appen, Afterpay and Altium have been bid up significantly over the year as bond yields collapse.

"A lower discount rate increases the present value of future cash flows, justifying higher valuations as interest rates fall, and fuelling multiple expansion driving gains to date. But these high growth cohort of stocks are hit hardest when volatility strikes as they are higher beta and lofty valuations leave no margin for error," she says.

Price chart | WAAAX stocks & ASX 200 ETF, 6 August 2019

ASX tech stocks

Source: Morningstar Premium

The big four banks were all significantly lower, with ANZ down 2.5 per cent to $26.62, Commonwealth down 1.8 per cent to $79.74, NAB down 2.5 per cent to $27.445 and Westpac down 2.6 per cent to $27.725.

Gold was the only sub-sector doing well as the price of the precious metal ticked higher, rising 1.3 per cent to $US1,465, as investors seek out safe havens to protect against volatility.

"Heightened geopolitical risks and a trade war escalation set to weigh on global growth increases the probability of an aggressive easing cycle from the US Fed, with a further rate cut set for September," Creagh says.

"This spurs demand from gold and dividend paying gold miners as a store of value in an environment of cheap money against a backdrop of the return of central bank largesse. Real rates also continue their collapse, which means that gold remains attractive."

with James Gard, content editor for Morningstar.co.uk

. Emma Rapaport is a reporter for Morningstar Australia.

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