Yuan Watch: Time To Buy Chinese Stocks?

By Bryan Rich 

July 5, 2016, 4:30am EST

Remember when China devalued the yuan back in August of last year?  The world went into a frenzied panic.  Was China going to do a massive one-off devaluation?  That was the fear that quickly triggered selling across global stock markets and bids in safe-havens (like bonds and gold).

Like the Brexit, not many could tell you why they were afraid of a yuan devaluation.  In fact, most didn’t even know that it was a relatively minor adjustment (that day), and that the devaluation of the yuan had already been underway since early 2014.

For some context, it’s important to understand that China had been, since 2005, slowly allowing their currency (the yuan) to appreciate — mainly versus the dollar.

It was China’s weak currency policy (i.e. manipulation) that was a large contributor to the credit bubble and burst, and the mass global capital and trade imbalances that remain as a major structural flaw in the global economy that feeds cycles of credit booms and busts.

The currency was their tool to corner the world’s export market — to be the exporter to the world.  They did it very successfully, and with little pushback for more than a decade.  And they ascended to one of the largest economies in the world in the process, stockpiling the world’s largest currency reserves.

With that, back in 2005, the leading economies in the world, led by the U.S., finally began threatening China with draconian tariffs IF they didn’t abandon their unfair currency policies.

It was at that point that China finally made a concession, to ward off the political and economic backlash.  They agreed to slowly allow the yuan to appreciate by abandoning their peg to the dollar, and creating a trading band around (primarily) the dollar.

In the chart below, you can see the peg (the straight line on the left side of the chart).  And you can see the policy change – the declining line represents the dollar falling in value vs. the Chinese yuan.

cny
Source: Billionaire’s Portfolio, Reuters
Who determines where the yuan trades in that band?  China.  So for 10 years, China allowed its currency to climb by only a meager 3% a year against the dollar.  That was enough to keep all of the protectionist threats at bay.  Meanwhile, their economy was growing at a double digit pace on average – which was a net big win, and that kept their global market share grab growing.  Even in the early stages of the global economic crisis, people thought China could take the torch and carry on with breakneck economic growth (Wall Street was telling us to pour our money into China and other emerging markets).  But soon China was exposed as heavily reliant on a healthy developed market world.  A healthy global consumer and a weak currency happened to be the magic formula after all.  And they’ve since been growing at about half the rate they were in the mid 2000s, which feels like recession, if not depression, in the Chinese economy.

Here’s a look at Chinese GDP growth …

china gdp 2
Source: Billionaire’s Portfolio, Reuters
So now, with the Chinese economy in a rut, the Chinese have tried a variety of monetary and fiscal stimulus measures but none have reversed the decline in growth.  Chinese growth at these levels is a real threat to
social stability – something the government is always very mindful of.

With that, enter the reversal of the yuan appreciation program of the past decade.   As of today, the yuan is 10% cheaper against the dollar than it was in early 2014.  Now, this path has been widely viewed as a signal of potential danger, raising such questions like: 1) Are things worse than we think in China?  Or 2) Will this provoke more protectionist actions from Chinese trading partners and geopolitical tensions?

But it could actually be quite positive for the global economy, at least near term.  If China devalues in a slow and orderly way, and it gets their economy going, it could be a much needed spark plug for global growth. If so, maybe it’s time to finally buy Chinese stocks.  You can see in the chart below, a weaker yuan tends to mean higher stocks in China.

STOCKS V YUAN
Source: Billionaire’s Portfolio, Reuters
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