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China Yuan

06/27/2012

As the second quarter closes out, investors continue to look for indicators to suggest an end to the current pause in market appreciation. As of the close on Tuesday, June 26, the S&P 500® Index (SPX) (Figure 1.1) is up 4.961% for 2012, but down 6.28% during Q2. It is no coincidence that the lousy Q2 performance correlates with this quarter’s sudden weakening of the China yuan (Figure 1.2).
 
I have repeatedly offered over the past few years that China’s currency appreciation is a much needed condition for appreciation in the global capital markets. Figure 1.3 below highlights the correlation between the yuan’s significant appreciation and the concurrent SPX appreciation beginning in late August 2010. Unfortunately, this quarter the appreciation stalled on May 2. In fact the yuan is positioned to close down over 1%, its worst quarterly performance since 2005.
 
The yuan is allowed to trade 1% on either side of the People’s Bank of China “fix,” otherwise known as the “reference rate,” which is currently at 6.3173 per U.S. Dollar. Trading in the yuan continues in recent days at the lower end of the fix band, an unfavorable condition.
 
While U.S. investors look toward our November presidential election, evidence from China is beginning to suggest the year-end presidential transition is also providing similar political uncertainty and, as a consequence, capital outflows from China.
 
Chinese President Hu Jintao retires from the Communist Party at year’s end and turns over the presidency in Q1 2013. He appears apprehensive to enact an aggressive growth strategy in his final days. It is obvious that investors, including myself, would like a more aggressive fiscal policy. Beyond reserve ratio requirement (RRR) and interest rate cuts, a mini-stimulus package would be incredibly favorable and is currently needed. 
 
For frustrated investors awaiting the 2012 tailwind from China, I highlight the importance of resuming yuan appreciation.  It is a simple indicator that has historically proven its worth.  I have not abandoned my belief that China will be a second half tailwind for the global markets, however, it appears that fiscal policy makers must first listen to the message from the markets – in particular its own currency market.
 
Figure 1.1 S&P 500 Index (SPX) Year To Date

Source:  Bloomberg

Figure 1.2 China Yuan Prior 52 Weeks

Source: Bloomberg
 
Figure 1.3 SPX to Yuan Correlation Beginning August 2010



Source: Bloomberg
 

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