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Conflicting Messages: Yuan And China Shares

Paul Baiocchi

The Chinese economy is sending more mixed signals than a prom date.

On the one hand, the renminbi just hit a new all-time high in dollar terms. On the other hand, the Shanghai Composite is down 4.5 percent year-to-date, and has lost more than 62 percent since hitting a closing high of 5,456 on Jan. 10, 2008.

For ETF investors looking at China and wondering just what the heck is going on, the chart below illustrates the ambiguity well.


FXI vs yuan since 2008


While the currency seems to be moving slowly and steadily higher against the greenback, the country’s equity market seems to be in the process of breaking down.

Even the blue-chip focused iShares FTSE China Index Fund (FXI) has been bleeding what looks like a slow death. In fact, a move below 2000 on the Shanghai composite—which closed 1.2 percent lower on Thursday at 2030.29—would spell certain doom in the eyes of technicians the world over.

Because of the opacity of the Chinese “market,” investors are ultimately left to decide which manipulated market is telling the truth.

On one side you have a “freely” floated currency that has been climbing higher week-by-week, year-by-year since it was unpegged less than a decade ago.

Of course, the value of the yuan is disproportionately impacted by policymakers as opposed to market participants, the latter group not allowed to move currency in and out of the Chinese system freely.

In other words, it’s hard to know just how much of the increase is due to real market forces and how much of it is due to manipulation by the central bank.

A dollar bear may make the case that the rise of the renminbi is the inevitable product of fiscal and monetary malfeasance in the United States.

A China bull may also argue that the rise is inevitable—but will be due to the sustained growth of the consumer class in China and the impact of economic expansion, rather than U.S. profligacy on the other side of the Pacific Ocean.

In their eyes, even an economy slowing from double-digit growth to high single-digit growth is a force to be reckoned with.



Not So Quick

But then there’s the blood bath that has been the Chinese equity market over the past four-plus years.

Publicly traded firms these days have valuations that suggest an economy that is extremely weak. Like the Chinese foreign exchange market, the equity market has significant restrictions and isn’t a completely open system open to any and all investors. In that way, this market signal is also distorted by the closed nature of the system.

Still, a China bear may point to the equity market meltdown and argue that it’s a symptom of overcapacity and misguided investment. Those China bears may also point to just how corrupt the Chinese system is and how little transparency there is into the country’s economic data.

Ultimately, your belief about the sustainability of the Chinese miracle and the trustworthiness of data coming out of China will shape the way you digest these trends.

If you believe that relative openness of the equity market makes it a more accurate harbinger of things to come, then owning FXI or any of the Chinese-focused ETFs—except perhaps inverse funds—is out of the question.

Conversely, if you believe the yuan’s steady rise in recent years signals China’s emergence as an increasingly developed economic superpower poised for an explosion of domestic demand, then the country’s equities are a screaming value.

Ultimately, the answer is probably somewhere in between.



At the time this article was written, the author had no positions in the securities mentioned. Contact Paul Baiocchi at pbaiocchi@indexunierse.com.


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