What was expected to be a one-time devaluation of the Chinese yuan on Tuesday proved to be more than that when China devalued its currency further on Wednesday.
The moves have caught markets by surprise, triggering a conversation about unexpected risks in China, the need for currency-hedging Chinese exposure, and even the possibility of having to bail out of China ETFs altogether.
Markets can react abruptly to surprises as doomsayers are advising investors to run for the exits. We spoke with five ETF advisors who share a more moderate view of the latest development.
Here’s what they had to say:
David Garff, president of Accuvest Global Advisors, a Walnut Creek, California-based firm known for its focus on single-country investing:
The devaluation was a surprise to most market participants. I always felt they would free-float the currency at some point if they want to reach their goal of being another reserve currency. I just didn't expect it to be so quick and such a large devaluation.
Clearly any sort of currency devaluation that is strong and long-lasting is a concern for U.S.-dollar investors, and we need to be aware of what’s going on. Currency moves create more uncertainty, which most view as riskier. I feel the same way.
The risk of a capital flight from China increases as the currency devalues. However, I don't agree with the doomsayers that say that we're in for another 1998 Asian currency crisis.
China has recently dropped in our ranking, mostly due to deteriorating momentum and fundamentals. Now, risks are increasing. So it would not surprise me to see China move even lower next month.
The short answer is that we need to be vigilant. Risk has increased. We have decreased, but not abandoned, our position in Chinese equities. This is another example of why currency-hedged ETFs are a great tool for us.
Mark Dow, founder of Dow Global Advisors and author of the Behavioral Macro blog, has 20-plus years of experience as a policymaker, investor and trader, focused on global macro and emerging markets:
My guess is if China intervenes today, it will be to slow the rate of depreciation, not engineer it. “Devaluation” connotes “disorderly,” but not this time. I can't see anything bearish about these Chinese FX moves, when put in the broader context. In fact, it's a bullish development. Looking backward for parallels rather than focusing on China's context is why so many are coming up with wrong conclusions.
I’m not bullish emerging markets yet. Emerging markets are in a serious bear market, and have been for a few years (2011 for equities, and since the 2013 “taper tantrum” for local currency fixed income). But there are good reasons to believe emerging markets this time around are not going to experience the kind of crashes, deep recessions and defaults they are famous for. Yes, I’m saying it’s different this time.
Among the reasons, most emerging markets now have flexible exchange rates and much higher levels of reserves relative to historical norms. The most spectacular emerging market crises took place inside the pressure cooker of fixed-exchange-rate regimes.
The imbalances built and built and built until they gave way in spectacular fashion, shocking investors and forcing liquidations. Today FX moves are continuous, and the ample reserves can be used to circuit-break and ensure continuous pricing, since they’re no longer needed to defend a peg.