Four Financial Hot Spots
Michael LeBlanc - Aug 14, 2015
When it rains it pours, as the saying goes. If you’ve been following the financial news this summer, it probably seems like a torrential storm has been churning all around the world. Every week, people ask me about the headlines they hear on TV. “Wha
When it rains it pours, as the saying goes. If you’ve been following the financial news this summer, it probably seems like a torrential storm has been churning all around the world. Every week, people ask me about the headlines they hear on TV. “What’s going on with China?” they want to know. “Is the Greece situation over?” “Why do I keep hearing more about Puerto Rico?” “What about Canada?”
You may have already seen my thoughts on some of these issues, but for the sake of convenience, I thought you might enjoy a quick round-up about what’s happening in the world and what it means for us. Let’s start in the Old World before returning to the New.
Greece Continues Its Odyssey with Austerity
Quick recap: for years now, Greece has struggled to pay down its massive debt, frequently turning to its European neighbors for help. The European Union (EU) has responded with bailouts, but this generosity comes at a cost: Greece has been forced to impose severe austerity measures on itself, mainly in the form of budget cuts and tax increases, in order to bring its debt under control. That has made life very difficult for Greece’s citizens, leaving thousands without jobs and no access to healthcare.
In June, Alexis Tsipras, the Greek prime minister, said “No more.” Despite the fact Greece could not make a scheduled debt payment to one of its creditors, Tsipras rejected the idea of accepting another bailout if it meant more austerity. A referendum was held in early July, asking Greek citizens whether to accept more austerity measures or not. Tsipras advocated the “Not” option, and over 60% of the country agreed with him.1 Tsipras, it seemed, had stared the EU in the eye and refused to blink.
Barely a week later, he blinked.
On July 13, Greece announced it had reached an agreement with its creditors: another bailout and more austerity.2 As of this writing, negotiations remain ongoing as to how much Greece must reduce their debt, and by when. Meanwhile, the economy continues to plunge even deeper into recession. For the Greeks, their national nightmare is far from over.
What does this mean for us? Well, the big worry was that Greece would be forced—or would choose—to leave the European Union. The concern was that a so-called “Grexit” would destabilize the entire continent, thereby upsetting the world economy at large. That seems less likely now. As a result, most observers have settled into “watch-and-wait” mode.
China’s Stock Market Hits a Great Wall
Now we travel east. After climbing 150% last year, the Chinese stock market came crashing down in June, falling over 30% between June 12 and July 8.3 It all started when millions of people—mostly working class families who previously had little to do with the markets—started pouring their money into stocks. This trend was driven largely by government-created hype. For months, state-owned media had been urging people to buy stocks, loudly proclaiming that the markets were the place to put their money.
As the demand for stocks increased, so too did stock prices. But that didn’t deter investors, who kept buying as long as stocks looked like they were going up. Many even borrowed money to keep buying. To make a long story short, stock prices rose too high, too fast. Meanwhile, the overall Chinese economy had actually been slowing down, and, despite its size, was thought by some analysts to be relatively weak in terms of growth.
The end result? A bubble. And as every little child knows, bubbles pop.
In June, investors finally woke to the fact that their nation’s economy wasn’t an effective prop for their nation’s markets... and that their own over-borrowing was a problem. Once again, investors acted emotionally—but this time, out of fear instead of greed. Their sudden loss in confidence led to a sharp sell-off in the stock market.
To stop the crisis, the Chinese government has thrown the book, sink, and even the bathtub against the wall to see what sticks. They essentially ordered Chinese brokerages to keep buying stocks, and even gave them money to do so. They instructed the rich and powerful not to sell. They prevented new companies from going public. They’ve even cut interest rates. For a time these measures seemed to work, and the country enjoyed a brief period of calm. But on July 27, the market dropped a whopping 8.5%, the largest fall since 2007.4
In response to this, and out of concern for their sluggish economy, China then took its most drastic measure yet: it devalued its own currency.
On August 10th and 11th, the People’s Bank of China reset the official exchange rate for the yuan at 6.33 per dollar.5 That’s almost a 2% drop in value. Why would China do this to its own currency? Because the cheaper the yuan is, the more affordable the country’s exports are. That makes it easier to sell goods and products to other countries, especially the United States and Europe. By extension, the more goods they sell, the stronger their own economy will become.
What does this mean for us? Like Greece, China’s stock market woes don’t affect the United States directly. It’s estimated that only 1.5% of Chinese shares are owned by foreigners, so most investors don’t have to worry about struggling Chinese companies in their portfolio.4 But, like Greece, the worry is that if China’s collapse continues, it could damage their overall economy. Because China is such a huge country, with such a large role in world affairs, their pain could potentially spread to other parts of the world. That’s especially true for those countries and industries that conduct a lot of business with China.
This is what makes China’s currency devaluation kind of a big deal. After all, when the yuan is cheaper, the dollar becomes more expensive. The end result? Just as Chinese manufacturers will now have an easier time exporting their products, U.S. manufacturers will have a harder time selling theirs. In fact, many companies who export to China—think car manufacturers, oil and mineral companies, and even retailers specializing in luxury goods—have already seen their stock prices fall. All across the world, major stock markets dipped in light of China’s decision, including both the Dow and S&P 500.
A further fear is that China’s devaluation will launch a “currency war.” This is when multiple countries all lower their own exchange rates at the same time in order to make their exports cheaper.
As you can see, the situation in China is almost as complex as the history of China itself. The safest thing to do at this point is to keep watching how events play out. A lot will depend on whether the Chinese government’s actions can stop the financial bleeding quickly… or whether they will devalue the yuan even further. Stay tuned.
Stress and Struggle in San Juan
Puerto Rico, the U.S. island territory, is a Caribbean jewel… but there’s trouble in paradise. The island has long been a popular tourist destination for its beauty and beaches, but a closer look reveals a territory mired in economic problems. Take their recession, for example, which began in 2006 and is still ongoing. In addition, a significant percentage of the population lives below the poverty line, and the government’s public debt is enormous.
How enormous? Try over $72 billion.5
In some respects, the situation is a little similar to Greece. In Puerto Rico’s case, the island defaulted on a $58 million bond payment on August 3rd.5 It’s their first default since becoming a U.S. territory in 1898. But while the U.S. government has certainly granted significant financial assistance to Puerto Rico over the years, it has officially nixed any suggestion of a Greece style bailout. One line of thinking is that a Puerto Rican bailout would set a bad precedent, encouraging other territories, cities, and even states to plead with Washington for emergency loans.
What does this mean for us? Well, some investors on the mainland are likely to be affected. That’s because a large part of Puerto Rico’s debt lies in the form of municipal bonds, which the local government issued so it could raise funds to pay for public infrastructure, like road and sewer maintenance, electricity… basic services that most of us take for granted.
One estimate says that over 20% American bond funds own bonds issued by Puerto Rico.6 That means regular investors who have invested in these funds also own bonds issued by Puerto Rico, at least indirectly. If the value of Puerto Rico’s bonds drop in value (they are already rated as junk status, meaning they are at a high risk of default), then those investors will feel the effects… or at least, their portfolios will.
And Finally… Canada
Stay with me, because we’re almost through. While the story here isn’t nearly as dramatic, we haven't been able to entirely escape the news. On July 31, Statistics Canada announced that the economy shrank by 0.2% in May.7 That doesn’t sound so bad, right? Unfortunately, it’s the fifth month in a row. In fact, the numbers for all of 2015 suggest that Canada is nearing the edge of a recession.
Technically, a recession is two straight quarters of falling GDP growth. Canada hasn’t quite reached that point, but it’s still a worrisome sign. The problem here is oil. Oil prices have continued to fall, sliding 20% in the month of July.8 While that’s good news for motorists, it’s bad news for the many Canadian companies that produce the stuff. Many of these companies have been forced to reduce spending and halt new business. If you remember the rule that one person’s spending is another person’s income, you’ll find it easy to understand why this could seriously harm Canada’s national economy.
What does this mean for us? At the moment, it’s unclear. But if there’s a prevailing theme to this message, it’s that we live in a global, interconnected world, with a global, interconnected economy. Stress in one region can potentially lead to tremors in another… and that is the reason for all the headlines.
That said, let’s remember something the media too often forgets: this sort of thing happens every month of every season of every year. Sure, things may seem out of the ordinary when you see a lot of headlines involving a lot of different countries all at once. But there are almost 200 countries on the planet. Some of them will always be at war, always be in a recession, and always be struggling with some issue or another.
To put it another way, it’s always raining somewhere.
So while I hope you found this quick trip around the globe informative, remember: we never make financial decisions based on the headlines. My team and I are always staying up-to-date, so if something ever happens that could affect your personal economy, you’ll be the first to know.
1 Suzanne Daley, “Greeks Reject Bailout Terms in Rebuff to European Leaders,” The New York Times, July 5, 2015.
2 Gabriele Steinhauser, Viktoria Dendrinou, Matthew Dalton, “Eurozone Leaders Reach Rescue Deal for Greece,” The Wall Street Journal, July
13, 2015. http://www.wsj.com/articles/eurozone-leaders-reach-unanimous-agreement-on-greece-says-eus-tusk-1436771076
3 Jennifer Duggan, “Chinese stock markets continue to nosedive,” The Guardian, July 8, 2015.
4 Charles Riley & Sophia Yan, “China’s stock market crash…in 2 minutes,” CNN Money, July 29, 2015.
5 Mary Williams Walsh, “Puerto Rico Defaults on Bond Payment,” The New York Times, August 3, 2015.
6 Frank Holmes, “Does Your Muni Bond Fund Own Puerto Rico’s Bad Debt?” Morningstar, July 29, 2015.
7 Nick Cunningham, “Canada is on the verge of a recession,” CNN Money, August 4, 2015.
8 Matt Egan, “Oil prices have plunged nearly 20%,” CNN Money, July 28, 2015. http://money.cnn.com/2015/07/28/investing/oil-prices-20-