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China –  Closing long stocks and staying short the yuan

Launched: November 13, 2014, and long stocks closed March 24, 2015.


Yet again, China's economy hit the skids in the first quarter for the fourth year in a row, raising the alarm that growth might miss the already lower target of around 7% in 2015. Meanwhile, stocks are ripping and ppp the yuan is slipping. MRP recommended going long stocks and shorting the currency last November. While stocks could have more to go as further stimulus measures are announced, MRP believes the rally is reaching the end of its current run and recommends closing out the long position in stocks. Since further stimulus measures are likely to include a weaker currency, we're keeping the yuan short a while longer.

On the growth side, the experts are divided on whether China will meet its 7% target, as today's Daily Intelligence Briefing shows. The Asian Development Bank is taking the over with 7.2% while the IMF is taking the under at 6.8%. On net, the consensus forecast as tracked by Bloomberg is at 7.0%, although expectations for 2016 are lower. At least in the short run, the stock market might have it right and growth expectations might be too low. Citigroup compiles an "Economic Surprise Index" that matches industrial production, exports, and other data against expectations; for China, that index turned up sharply in March, although it has since pulled back a bit.

GROWTH EXPECTATIONS HAVE DOWNSHIFTED BUT THE RECENT DATA HAS PICKED UP ...


 Source: Bloomberg, McAlinden Research


Unlike the experts, the stock market's dramatic rally is clearly pricing in stronger growth and further stimulus as the fiscal and monetary spigots are opened again. While policymakers have indicated a massive intervention isn't in the cards, targeted programs are being being deployed across wider sectors of the economy. Given the near-vertical trajectory of the stock market, it seems prudent to step away at this point and avoid the risk of a sudden sell off, particularly in light of MRP's high odds for a correction in US stocks which could easily spill over into global markets.


Meanwhile, the planners have finally been guiding the yuan down against the dollar. While the yuan is allowed to trade around a +/-2% trading band, the reference rate itself is set by the planners against a basket of currencies. Given the dollar's strength over the last year, a weaker yuan is overdue and complements the other stimulus measures. While the yuan has strengthened a bit in the last week, MRP expects it to resume a weaker trend into the next quarter.

Last updated March 24, 2015
 
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Warren Hatch, PhD, CFA
Portfolio Management and Global Investment Strategy
McAlinden Research Partners

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