Legendary investors are made by their ability to anticipate the trends that will shape markets well before those trends are widely seen or priced into the market. Super-investor Warren Buffett closed out much of his derivatives exposure from subsidiary General Re by 2005, well before derivatives hit the wall from 2007 to 2009, which helped him avoid the meltdown.
A growing chorus, including the voices of the Obama administration and prominent economists such as Fed Chairman Ben Bernanke, have been calling for a change that will cause a massive shift in international trade. This means agile investors have an opportunity to play this change before it's fully reflected in share prices.
Excellent exchange
This massive shift concerns China's exchange rate, which many analysts view as simply too low and as destabilizing for global trade. Since 1995, China has kept its rate effectively pegged to the dollar, at a low level that makes its exports ultracompetitive in world markets.
Only last week did the nation suggest that it would let its currency appreciate -- but the million-dollar question is, "By how much?" Last week, the renminbi rose against the dollar a mere 0.53%. That gain wouldn't be worth noting, except that it signals the prospect for future gains.
Experts such as Nobel laureate Paul Krugman still consider the renminbi underpriced. Goldman Sachs has predicted a rise, and Wells Fargo has suggested that the renminbi could gain as much as 15% by the end of next year. Still other analysts believe the renminbi is 40% undervalued. In any case, those would be massive tailwinds to well-positioned Chinese stocks.
Why the renminbi will likely continue to rise
To maintain a fixed exchange rate, China has had to buys tens of billions of dollars every month in order to resist the pressure toward currency appreciation caused by the inundation of foreign capital into its too-cheap markets.
As if that weren't enough, China's exchange rate policy is hindering policymakers' efforts get developed economies humming along again. As the Federal Reserve reduced interest rates to jump-start America, the dollar depreciated relative to other currencies. Since the renminbi was tied to the dollar, U.S. exports gained little to no advantage against China, while Europe suffered further. China effectively "piggybacked" American efforts.
As Krugman explains, "In the current environment, with high unemployment around the world and policy interest rates as low as they can go, this is a predatory, beggar-thy-neighbor policy."
Throughout this saga, China has complained bitterly about high inflation, and lamented its extensive holdings in dollars. As both Bernanke and a group of Citigroup analysts noted, currency appreciation would help tame China's inflation, helping it buy the natural resources it so desperately needs.
How now, Mao?
As I hinted above, one solution to this situation is for China to allow the renminbi to appreciate relative to the dollar. If China did this, the immediate effect would be to hurt its export-reliant industries such as manufacturing. That increase in costs would slap major importers from China such as Apple (Nasdaq: AAPL ) and Dell (Nasdaq: DELL ) , which source products from there.
However, the currency move would help American companies that are quickly expanding Chinese operations. Nike (NYSE: NKE ) boasted sales of $1.7 billion in its Greater China division last year, as revenue really bloomed since 2005. Coca-Cola (NYSE: KO ) also looks to the nation for growth, and now owns some 50% of the domestic soft-drink market. But obviously, these companies are not pure plays on China, and they won't experience the full burst of the renminbi's appreciation. To find such an opportunity, it's a good idea to look at Chinese companies.
But rather than haphazardly buying Chinese stocks, and hoping that American and Chinese politicians can come to an agreement, a better strategy is to find absolutely solid Chinese companies that are thriving now and will continue to thrive if and when the renminbi appreciates. Then currency gains can become the tailwind to a great investment.
Stocks such as these would be likely winners from currency appreciation:
|
Company
|
Industry
|
Trailing Return on Equity
|
5-Year Compound Earnings Growth
|
|
Baidu (Nasdaq: BIDU )
|
Internet services
|
42.2%
|
166%
|
|
SINA (Nasdaq: SINA )
|
Internet services
|
46.4%
|
48%
|
|
Yongye International (Nasdaq: YONG )
|
Agriculture
|
3.8%
|
133%*
|
Source: Capital IQ, a division of Standard & Poor's.
* 2-year growth in operating earnings.
By buying an efficient and reasonably priced company such as Yongye International, you have the opportunity to profit from an undervalued company, as well as the appreciation of the renminbi.
Better still, your investment gains in dollar terms, even if the stock's relative valuation remains the same. Because currency appreciation, not investors' willingness to pay a higher P/E, is driving the stock up, a cheap company is still cheap, and you've captured a currency gain for free. Tack on the power of multiple expansion, and you can quickly see blockbuster returns.
An interesting proposition
There's plenty of noise in policy circles about China's cheap currency, but what does it look like on the ground? Our Motley Fool Global Gains team is headed there next week to find out. If you'd like to hear about what they find, just enter your email in the box below to get real-time dispatches to your inbox.
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