From Credit Suisse (4/26/10):
“One of the most widely expected events this year is a RMB revaluation. We believe that there will be slightly more RMB/Asian currencies revaluation than is discounted by the markets. Our head of Asia economics, Dong Tao, expects a 3–5% revaluation this year (starting mid-year) and 5% in 2011E (more than the forward curve, which is discounting 3.2% appreciation over the next 12 months). Moreover, our FX team’s model estimates that the RMB is 49% undervalued, with the Won and NT$ being 30% and 31% undervalued (in our opinion the RMB is overvalued until the current account is in deficit by 3% of GDP; currently there is a 5.5% surplus).
We think RMB appreciation makes sense as it would likely: a) avoid punitive import tariffs (e.g., the Schumer/Graham bill); and b) control overheating (we estimate each 10% on the RMB takes 0.9% off inflation and 1.2% off GDP). In July 2005, the RMB initially revalued 2.1%, but then appreciated 19% against the dollar over the next three years. A quick sharp revaluation in the RMB (10%+) is both unlikely and counterproductive—we see optimal revaluation as moderate and slow (which is likely).
The winners. The last time the RMB revalued (in July 2005), Japan outperformed 25% in the subsequent six months (and we think it could outperform again with 55% of exports going to NJA: we like Nitto Denko, TDK, Asahi Glass) and Non-Japan Asia outperformed marginally. We believe that a small currency appreciation could lead to unsterilised capital inflows and thus an asset bubble (in China, according to Dong Tao, only about 40% of capital inflows are sterilised). Hong Kong retail property owners could benefit (as HIBOR is driven down and Chinese consumers go to Hong Kong to shop): Great Eagle trades on a 39% discount to NAV.
From a sector point of view, after the last RMB revaluation the clear winner was metals/mining, outperforming by 31% over the following six months (and Chinese property stocks, which outperformed by nearly 60%). We see the big long-term winners as the China/Non-Japan Asia consumer plays. The NJA consumer share of GDP is just 45% and 35% in China (compared with 71% in the US) and currency appreciation is about redirecting exports/investment to consumption. Stocks that look cheap on Credit Suisse HOLT® and have more than 10% of sales to NJA include: Millennium & Copthorne, SAB Miller, WPP, HSBC, Cisco, Pepsi, Motorola, Belle and China Mobile. We believe tech is a winner, with China accounting for nearly a fifth of PC & handset demand, the PC penetration rate being just 15% and PCs being particularly price sensitive. Some companies that compete against Chinese manufacturers would likely benefit from a boost to their competitive position (Verso, PKG, Ericsson, Siemens, ArcelorMittal, CAT, Cummins). Companies sourcing from China are likely to suffer: e.g., retailing, with half of textile costs from China.
We stick to an overweight of NJA: the implied growth premium (13%) is much less than the GDP growth premium (108%); NJA can outperform even if lead indicators roll-over prior to the first Fed rate hike; a negative real Fed Funds rate is typically supportive; finally, regional risk appetite is back to just neutral levels (relative to global markets).”
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.
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