China Raises Rates: Buy on the Dip

Includes: CAF, FXI, GXC, PGJ
by: NewstraderFX

Absent another blow up of European debt or geo-political risk event, if U.S. stocks dip as a result of China’s rate increases it likely will present a good buying opportunity.

First, a rate increase from The People's Bank could actually serve to stimulate demand in China's economy (see Part 2 of this article from Michael Pettis for further analysis of the subject) since the deposit rate was also adjusted up.

Second, while the exact timing of the move may have come as a bit of a surprise, the announcement itself certainly was not. Actually, investors may be relieved to find the increase was only 25 basis points.

China raised borrowing costs for the first time in nearly 3 years back on October 19th after U.S. markets had closed. Following declines in Asia and Europe, the DOW fell 165 points, or 1.5%, to 10978 while the broader S&P’s 500-stock index dropped 19 points, 1.6%, to 1165.90 the next day. But even with the blow-up over Irish debt that began a few weeks later, the indices have gained 5.4% and 7.8% respectively since then, completing the retracement of declines which began after Lehman collapsed.

Also hurting sentiment that day was a report that a consortium of major investment firms including Pimco and BlackRock, along with the NY Federal Reserve Bank, were attempting to force Bank of America to buyback almost $47 billion in bundled mortgages put out by Countrywide Financial, which was bought by BoA in 2008.

Absent the afore mentioned calamities, it's hard to be bearish when there's an abundance of liquidity (see Where Did The Fed's $700 billion Go?) sloshing around the system, with more still to come from another $800 billion of QE in addition to the 2% payroll tax reduction (the $800 billion comes from $600 billion in new purchases plus another $300 billion to be re-invested from maturing MBS, minus the $100 billion already purchased).

The Rabid Right appears to have quieted down for the moment regarding QE2, likely after realizing their views were aligned with the largest currency manipulator in world history (or perhaps after looking over their latest 401k statements). And while you can never prove a negative, for better or worse the Fed has created a wealth effect via the stock market which has translated to the strongest Christmas spending in years.

Therefore, if it ain't broke, don't fix it.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.