6/22/2010
By David Urani, Research Analyst

China has finally done it. After months upon months of clamoring by the U.S. and other nations to un-peg the Yuan from the dollar, China has decided to allow its currency to rise. No longer will the currency be stuck in the same place against the greenback to boost the Country's exports, and the decision has alerted investors to the possibility of a significant shift in global trade, and possibly even a different look to the Chinese economy. Given all of the economic and sovereign debt problems in the U.S. and Europe, it's quite possible that the Yuan's "real" value is in the double-digit percentages above its current level, and that would certainly put a twist on international commerce.

Only Fools Rush In

China's Yuan decision is probably a good thing for the world economy and international relations, and there's going to be much hype around it.  However, the way I see it, it's one component in the bigger scheme of things. Two days after the Yuan decision, little has changed. The Yuan is now a grand total of 0.3% higher versus the dollar than it was to start the week. That's because the Chinese government has set a 0.5% limit in the amount it can increase per day. In fact, we know now that the Yuan may actually decrease some days as the government also has a trading platform set up in which it can trade against speculators to keep the currency from rising too quickly. Therein lays our skepticism. Although the Yuan is "un-pegged" it is still under tight control by China and not by any means on the free market. In that respect, China's action could be as much of a PR move as anything as it heads into G20 discussions. Nevertheless, over time we should see the Yuan make meaningful progress, although my intuition says it will take months before it moves enough to impact corporate strategy for companies that do business with, or in, China.

Yuan to Dollar

Also keep in mind China is dealing with its own economic issues. Actually, it is dealing with somewhat of the opposite scenario as everyone else in that its government is taking measures to cool down its economy to prevent a bubble. The Chinese real estate market in particular has been ringing alarm bells; home prices are up more than 12% year over year. A number of regulations have been enacted to slow real estate in some cities and it has been successful; take Shanghai for instance which saw home sales fall 23% in one week. Economic cooling has also seen China's manufacturing PMI index fall to a reading of 53.9 in May from 55.2 in April. Keep in mind that Yuan revaluation may also be a step to curb inflation in China, where consumer prices rose 3.1% in May, and more than 2% in each of the three previous months.

What to Look For

Traders already have a number of investments in mind and they will be watching the Yuan's rise daily to add to positions. China's improved importing power will be highlighted, particularly in the industrial sector where it does heavy importing to support its rapid infrastructure expansion. Bandwagon investments in the industrial sector will include raw materials, particularly metals and their international producers such as BHP Billiton (BHP) and Vale S.A. (VALE), and machinery exporters such as Caterpillar (CAT). However, I have my reservations about the industrial side. Slower construction and manufacturing as mentioned above are the reasons we are more cautious on industrial names. We would also stay away from Chinese producer/exporters since Chinese goods will become relatively more expensive.

On the flip side, a stronger Yuan would empower the Chinese consumer and make foreign goods less expensive (while the aforementioned inflation does hurt consumer purchasing power, the rising Yuan will help to offset it). International businesses operating in China also stand to gain from a forex boost to sales. Therefore, we are most bullish on the international consumer companies in China as a way to invest in the currency's new freedom. Take for instance Yum Brands (YUM), the operator of KFC and Dominos, which does 30% of its sales in China (f.y.i. it was the first fast food restaurant to offer drive-through and pizza delivery in China). Consumers in China will also be more empowered to travel internationally, and jet fuel could even become more affordable so look out for the likes of China Southern Airlines (ZNH), China Eastern Airlines (CEA), and Ctrip.com (CTRP). (Also see Brian Sozzi's good and bad moves in retail here).

David Urani
Wall Street Strategies