Remember when everyone said the U.S. dollar was going to collapse because of quantitative easing? In fact, the opposite happened. The dollar is too strong (up 40% in the last four years), especially for countries that peg its currency to ours. To compete with Japan’s falling yen and bump up its own exports, China needs its own currency (the Yuan, aka Renminbi or RMB) to be weaker.
We have regular conversations with the ‘boots on the ground’ in foreign countries and subscriptions to millions of data series that tie together the qualitative story abroad with the quantitative.
Ashmore, a large global asset manager, penned a nice note on the currency moves in China. Jan Dehn wrote, “Closing the gap between the fixing and market based valuations of the Renminbi (RMB) is one of the key requirements for SDR (Special Drawing Rights) inclusion [the International Monetary Fund recommends inclusion as a ‘usable’ currency]. This action therefore takes China one step closer to SDR inclusion – set formally to happen this year with practical implementation starting around the time of the G20 summit to be held in November 2016 (where Obama will give his nod of approval as a final gesture before leaving office). SDR inclusion in turn is part of a much broader set of reforms.”
Ashmore’s note continues, “Remember why China is implementing reforms, including liberalizing its currency regime. The entire purpose of the reforms is to prepare the economy for Renminbi appreciation, i.e. a rise in the Yuan once QE (Quantitative Easing) across the Western world creates inflation and currency weakness in the QE countries. Inflation is likely to begin in late 2016 in the U.S. as the drags on consumers’ willingness to respond to plentiful and cheap liquidity form household deleveraging, negative housing equity, and unemployment ease.”
While we are yet to see the inflation data domestically, there is no denying the healing of household balance sheets and confidence in the U.S. Consumer credit grew 7% in the second quarter, the fastest pace in a year. Foreclosures and delinquent mortgages hit the lowest levels since 2007. Our data measure for retail and food sales adjusted for both population and inflation grew at 2.6% year-over-year in July, which historically correlates to normal growth.
Turning back to China, what has garnered so much attention the last few months is the epic rise and fall of the Shanghai Stock Index. However, this really is not the stock market to be watching if one is a foreigner invested in Chinese companies. The A-Shares that trade on the Shanghai exchange just opened up to non-residents in November 2014, with very strict trading limits. Thus, most investors not based in China are in H-shares, which trade on the Hong Kong Stock Exchange.
The chart below shows the difference of performance over the past year. The A-share is the market that crashed (yet still up nearly 100% from a year ago), while the H-shares rose and sold off more gradually the last several months.
Today valuation of H-shares are the cheapest since 2003 against the A-Shares. The MSCI China Index (made up of H-shares) trades at a 10.6 times price to earnings (P/E) ratio and a 2.9% dividend yield. This compares to the MSCI China A-Share Index trading at a 20 times P/E ratio and a 1.5% dividend yield.
In terms of growth, the electricity and power data do not corroborate the official Chinese statistics of 7% real GDP growth. These non-official statistics reflect much slower growth, more on par with what China expert economist and professor Michael Pettis put at a 3% long-term and terminal growth rate. It will be a process as growth rebalances from investment to consumption driven, with many structural changes needed. Lower growth does not necessarily mean financial assets will perform poorly (the bond market is growing and offering attractive yields, which does not get much airplay). Numerous studies show there is a zero correlation between economic growth and stock market performance. This can be attributed to investors anticipating massive growth and chasing the markets higher, only to, on average, be disappointed by the subsequent data.
This excitement phase happened in the mid 2000’s and peaked in 2010; the last few years were disappointing, with fair values finally being served up to investors.
This material is based on public information as of the specified date, and may be stale thereafter. Aurum Wealth Management Group and/or Aurum Advisory Services has no obligation to provide updated information on the securities or information mentioned herein. Actual events may differ from those assumed and changes to any assumptions may have a material impact on any projections or estimates.