What's happening in China should be a major concern for TSX investors

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On Monday, major North American markets were all up over one per cent. Tuesday, it was a mirror image.

The S&P/TSX composite index rallied 163 points or 1.1 per cent on Monday. Tuesday, the index was down by more than that at one point during the trading day, and ended down nearly 0.4 per cent.

The current situation with China is a concern, a major concern, and it is not going away any time soon. On Monday, investors shrugged off the terrible economic import/export data out of China, a mistake in my opinion. China also reported weak July auto sales, down 7.1 per cent year-over-year, the largest drop in over two years, and Money Supply M2 increased 13.3 per cent year-over-year in July with China authorities pumping cash into the system. Manufacturing activity is contracting, too, with the July Manufacturing Purchasing Managers' Index was at 47.8, down from 49.4 in the previous month.

Yet another reason to be concerned about China: U.S. companies such as Whirlpool and IBM recently reported declining Chinese sales. The Chinese economy is a key reason why I have been recommending investors use rallies in stocks to take some profits off the table in my daily Before the Bell report. I see the S&P/TSX composite index retesting the 14,000 level in the near term.

The slowing Chinese economy, and instability in its equity markets, is a concern to North American markets as stocks operate in a global economy, with China playing a key role. The slowdown in China's economy is a legitimate reason for investors to have concerns, particularly for resource stocks and companies with significant exposure to China. The announcement of the devaluation of the yuan is having the largest impact on currencies and commodities. With the energy and materials sectors representing 18 per cent and nearly 10 per cent respectively, in the S&P/TSX composite index, an extended and deepening Chinese economic slowdown has major ramifications for the Canadian stock market.

West Texas Intermediate crude oil futures were down nearly four per cent Tuesday for two reasons. At the forefront is China. China is the world's second largest consumer of oil, behind the United States. The devaluation of the yuan has implication for oil as it makes crude oil more expensive, as oil is priced in U.S. dollars. This higher cost may decrease demand. Not a good situation when the supply of oil is so high. The other negative driver for the downdraft in the price of oil today was a monthly report from the Organization of Petroleum Exporting Countries (OPEC) showing production in July rose to a three-year high, with no increase in demand forecast this year. High production from OPEC and non-OPEC countries has created an oversupplied oil market, and more supply will soon be coming on-line from Iran.

Additional implications lie with the U.S. dollar and whether or not the U.S. Federal Reserve delays increasing interest rates. As we saw Tuesday, Chinese authorities will continue to take actions to control the slide in its economic growth. Atlanta Fed President, Dennis Lockhart, made recent hawkish comments stating that it would, "Take a significant deterioration in the economic picture for me to support a delay in lifting interest rates past September." Then you have Stanley Fischer, the Federal Reserve's vice chairman, concerned with the risk of raising rates when inflation is very low. Does China's currency devaluation change the path for the U.S. Federal Reserve? It is unclear. What is clear is that the U.S. labour market continues to improve, and investors should watch for the U.S. June JOLTS job opening report on Wednesday and the  U.S. retail sales report due out this Thursday for indications to the health of the U.S. economy. Note that U.S. Fed Chair Janet Yellen indicated on July 29 in the FOMC statement that the committee will assess and take into account "international developments."

What does the devaluation of the Yuan mean for investors? Markets will remain volatile. I believe the downtrend remains intact and that we have not seen a bottom yet. I would continue to avoid resource stocks. While these companies are trading at low valuations, the fundamentals remain weak.