Yesterday, China's announcement that it was cutting interest rates by a quarter-point caused an extension of Wednesday's big rally for stock markets in the U.S. and around the world. Investors took the move as a sign that other governments might soon join the Chinese in easing monetary policy, leading to another boost of liquidity to push stock prices higher.
However, lost in the initial push higher was a look at the more direct effects that lower rates in China would have. Although China's economy has grown large enough that its economic moves undoubtedly have a global impact, you still shouldn't ignore the more obvious beneficiaries of policy moves within the world's most populous nation.
Looking from all perspectives
Economically sensitive stocks in the U.S. gained after the rate cut for an obvious reason: A stronger Chinese economy makes their businesses in China healthier. As many U.S. companies have latched onto China in the hopes it will become a big driver of overall growth, their movements have more closely tracked China's economic demand.
But U.S. companies enjoy only second- or third-order effects from a rate cut. By contrast, many other companies have a much clearer stake in interest rates in China. Let's take a look at some of them.
1. Chinese financial companies
The Chinese banking industry has the clearest link to interest rates. Changes in rates can affect banks' profitability, as well as loan and deposit demand. In this case, the rate cut has offsetting impacts. Because the People's Bank of China cut both loan and deposit rates, the spreads that banks earn should stay the same at slightly more than 3 percentage points.
One key, though, is that banks can now offer 20% discounts on loan rates, up from the former 10%. So with the upper limit on deposit rates 10% above the benchmark deposit rate, banks have more flexibility now to compete with each other. The impact could be better deals for customers but lower profits for banks.
That's especially important for investors in the iShares FTSE China ETF (NYSE: FXI ) , because more than half of its assets are tied to financial companies. The modest rise in the ETF yesterday shows the ambivalence that market participants have toward lower rates in China.
2. Chinese exporters and domestic producers
For years, the value of China's currency has fallen steadily. Although tightly controlled by the government, exchange rates have floated with permissible ranges that have decreased over time. From its level of 8.3 yuan to the U.S. dollar before 2006, the currency has now appreciated to just 6.35 to the dollar.
But over the past several months, the yuan has stopped rising and actually dropped somewhat as economic growth has slowed. Lower interest rates should theoretically drive the yuan lower still, which in turn should help companies that rely on exports for their success.
By the same argument, domestic producers that have to compete against international importers will have a currency-related advantage. Multinationals will suffer from smaller profits in their home currencies if the yuan keeps weakening.
For instance, Aluminum Corp. of China (NYSE: ACH ) , also known as Chinalco, competes against Alcoa (NYSE: AA ) in production of aluminum for the Chinese market. If lower rates lead to a weaker yuan, then Alcoa will earn less in U.S. dollar terms from selling into China, giving Chinalco a competitive advantage. Similarly, CNOOC (NYSE: CEO ) should gain some advantages over companies delivering oil and gas to China.
3. China's growth leaders
In the long run, though, the biggest winners could be those companies that stand to grow the most in a healthy Chinese economy. Baidu (Nasdaq: BIDU ) was a nice winner yesterday, rising almost 3% in U.S. trading after the rate cut announcement. Baidu clearly has opportunities globally, but strength in its home market is still extremely helpful for the company.
None of this is to say that other companies in the U.S. and elsewhere won't benefit from China's rate cut. But just as you would first look to U.S. stocks if the Federal Reserve cut rates, you shouldn't ignore Chinese stocks when China's banks cuts rates. Given how far Chinese stocks have fallen, ignoring China's stock market could lead you to miss out on some lucrative profit opportunities.
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