Download With respect to China`s recent devaluation of their currency, the

With respect to China’s recent devaluation of their currency, the renminbi, we think it’s the latter. The
key motive behind this move appears to be the ruling party’s decision to see their currency included in
the International Monetary Fund’s (IMF) basket of reserve currencies, known as Special Drawing Rights
(SDRs), which currently includes the U.S. dollar, the Japanese yen, the euro and the British pound.
The IMF’s decision is likely to be based on one key determinant: the degree to which the renminbi is
freely traded around the globe. The timing of China’s announcement, the nature of their actions, the
IMF’s response and the China central bank’s (PBOC) support of the currency after the initial
devaluation all point to the SDR
China’s Currency Devaluation In Perspective
initiative as the central motive.
China’s action makes the renminbi
valuation more market-based, which
is one of many steps toward a more
freely traded global currency.
To be fair, China has to be
anticipating the U.S. Fed’s rate
hikes later this year, which is likely to
affect our currency and therefore
theirs. Additionally, as China’s
economy has slowed, their export
growth has fallen off. A devaluation
in their currency would undoubtedly
Source: New York Times, August 11, 2015
help that. However, these appear to
be collateral benefits to the more
lasting benefits achieved through SDR status.
What has the world’s stock markets spooked right now is the threat of an all-out currency war –
intentional or inadvertent – that will unleash another round of global deflation. Make no mistake, that
could be the outcome… and deflation would be a much harder thing for the world’s central banks to
solve than inflation ever is. However, a prolonged currency war would not be beneficial to China’s or
the global economy. And any short-minded emphasis on export-led growth would be counter to the
ruling party’s stated intent to shift to a more internally-focused, consumer-driven economy. So, unless
the ruling party has changed its long-term plan, perhaps we should believe them when they say
they’ve re-emphasized their desire to make their exchange rate more market-driven, while continuing
to maintain stability in the currency. In fact, in response to the markets’ reaction, we could see
additional supportive measures, including interest rate cuts, reduced reserve requirements and maybe
outright buying by government entities… and they have $3.7 trillion in foreign exchange reserves to
use as a tool.
Even so, the world’s stock markets have pulled back hard this quarter, especially in the last week. Our
assessment of the retreat has us believing that this is simply a market correction, rather than the end of
the bull market and start of a new bear cycle. This correction is long overdue. In fact, we haven’t seen
a meaningful correction in the U.S. stock market since the third quarter of 2011, when the S&P 500
was off 19% peak-to-trough. Since then, there hasn’t been a peak-to-trough pullback that exceeded
6%, which is very mild by historical standards. Our view is that the Chinese devaluation and its likely
effects do not pack the punch that will spawn a global recession and deflationary spiral. In fact, this
scenario doesn’t seem as dire as those events that triggered the last two significant market corrections.
The aforementioned correction in the third quarter of 2011 was driven by the threat of “fiscal cliff”.
Prior to that, the S&P 500 suffered a 17% peak-to-trough pullback in the second quarter of 2010, as
we were staring into the teeth of a European debt crisis. Both of those seemed more serious than what
we’ve got on our hands right now. Therefore, while market sentiment may drive the markets down
some still, this pullback may ultimately be a softer one than the prior two “real” corrections.
Before I talk about portfolio tactics, let me offer some perspective on the effect of recent market action
on your portfolio. Here is a recap of quarter-to-date (QTD) performance across the various asset
classes (as indicated by their various indices):
Asset Class
QTD
Return
Stocks:
U.S. Large Cap Stocks
U.S. Mid Cap Stocks
U.S. Small Cap Stocks
Developed Market Intl. Stocks
Emerging Market Stocks
-4.2%
-4.4%
-7.6%
-4.4%
-17.3%
Bonds:
U.S. Municipal Bonds
U.S. Taxable Bonds
High Yield Bonds
Emerging Market Bonds
1.1%
1.2%
-2.7%
-2.6%
Diversifying Investments:
Commodities
Global Real Estate
Hedge Strategies
Reinsurance Bonds
-14.5%
1.4%
-0.3%
1.8%
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It’s clear that there has been across-the-board damage in stocks this quarter. The silver lining is that
high-quality bonds and diversifying investments (or at least those in which we’ve chosen to have
exposure) have held up quite well, with some actually up slightly.
It’s also clear that this quarter has offered a great “advertisement” for fully-diversified portfolios. With
that in mind, here’s a recap of our portfolio tactics this year:
 We’ve chosen to be significantly overweight Developed Market Stocks (U.S. and Europe, and
to a lesser extent Japan), while remaining at an underweight to Emerging Market Stocks. The
performance differential has been dramatic!
 We did a tremendous amount of research early in the year in seeking out bond managers with
very flexible mandates – those that can be very nimble in how they position themselves on the
yield curve and across the various sectors of the bond market. We did this so we could
balance capturing the current yield available to us in bonds today with the realization that the
Fed will start raising interest rates fairly soon.
 We eliminated our exposure to Emerging Market Bonds earlier in the year.
 We maintained zero exposure to Commodities going back to 2013, while we remain in a
global disinflationary environment.
 We maintained positions in direct Real Estate and Reinsurance Risk Premium portfolios, which
gave us uncorrelated (and still-positive) returns this year.
 We identified strategies that provide direct and indirect hedges against our stock and bond
positions. These positions have held up well during the stock market pullback.
If this is, in fact, a market correction in stocks, rather than the start of a new bear market, then it’s our
preference to stay invested for now. If we’re wrong, if our fundamental and technical models start
flashing a lot of red at us, then we’ll move to more aggressive defensive measures, as we have in the
past. In the meantime, we’re comforted by the way in which your fully-diversified portfolio is holding its
ground.
We hope you’re enjoying a great summer and, as always, we thank you for your business and your
confidence in what we do. It’s why we’re here!
Until next time,
Mark Pellegrino
Managing Principal, Rainier Group Investment Advisory
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Source: Black Diamond. Returns presented reflect the time period June 30, 2015 through August 21, 2015. The
benchmarks shown are unmanaged indices that represent suitable comparisons between the recommended funds and their
representative market sector. The S&P 500 Index is a market capitalization-weighted index of 500 large U.S. stocks. The
Russell Midcap Index is a market capitalization-weighted index of mid-cap U.S. stocks. The Russell 2000 Index is a market
capitalization-weighted index of 2000 small U.S. stocks. The MSCI EAFE (USD) is a U.S. dollar-denominated market
capitalization-weighted index of developed international stocks. The iShares MSCI Emerging Markets Index ETF is an
exchange-traded fund that is designed to track a U.S. dollar-denominated market capitalization-weighted index of emerging
market stocks. The Barclays Intermediate Government/Credit Bond Index is a market capitalization-weighted index of
intermediate-term U.S. government, mortgage and corporate bonds, representative of taxable bonds. The Barclays
Municipal Bond Index is a market capitalization-weighted index of U.S. tax-exempt municipal bonds. The Barclays High
Yield Bond Index is a market capitalization-weighted index of high yield or below-investment-grade bonds. The iShares JP
Morgan USD Emerging Markets Bond ETF is exchanged traded fund designed to track the U.S. dollar denominated returns
of an asset-weighted index of emerging markets bonds. The IQ Hedge Multi-Strategy Index seeks to replicate the riskadjusted return characteristics of hedge strategies using various hedge fund investment styles, including long/short equity,
global macro, market neutral, event-driven, fixed income arbitrage and emerging markets. The DJ/UBS Commodity Index is
a value-weighted index of 14 commodity futures. The FTSE NAREIT Index is a market capitalization weighted index of global
real estate investment trusts. The Stone Ridge Reinsurance Risk Premium Bond Fund is a proxy for reinsurance bonds.
Investments are not guaranteed or insured by a bank or any other financial institution and have the possibility of a loss. The
performance data shows past performance and is not a guarantee of future results. Principal value and investment returns
will fluctuate. This report uses information that is considered reliable, but it does not represent that the information is
accurate or complete, and the report may not be relied upon as such. The report is not intended to be either an expressed
or implied guaranty of actual performance. It is not intended to supply tax or legal advice. There is no solicitation to buy or
sell securities. Additional information is available on request.
Views expressed in this summary are the opinions of The Rainier Group, Inc. This report is intended for private circulation
and distribution only.
If you have any questions about your portfolio or this report, please contact us at (425)463-3000 or (800)800-8974.
At The Rainier Group, we stand ready to assist you with your financial decisions. Thank you for entrusting us with your
investments.
© 2015 The Rainier Group, Inc.
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