The Chinese Yuan Devaluation, 1 Week In

|
Includes: CNY, MCHI
by: Marvin Hah

Summary

China devalued its currency by 1.9% last week, leading to weaker Asian currencies across the board.

Equity markets suffered with worries that China's economy is worse than expected and fears of a deflationary spiral.

We look at how Asian currencies and markets have performed one week after the yuan's devaluation.

On August 11, the People's Bank of China devalued its currency by 1.9%, the nation's most drastic devaluation in two decades. The ripples from this devaluation extended beyond the currency markets; equity markets have reeled on the move. So far, the onshore Chinese yuan (CNY) has fallen by 3% since that day, while its more liquid counterpart, the offshore Chinese yuan (CNH) has fallen by 3.5%.

The PBoC has also signaled that it was shifting towards a more market-driven exchange rate regime from a USD-centric one. This move benefits China in two ways: (1) it increases the odds of the renminbi's inclusion in the Special Drawing Rights (NYSE:SDR) at the IMF's year-end review, and (2) it helps with the country's exports though the central bank has categorically denied that the aim of the devaluation was to boost exports.

Offshore Chinese Yuan Price Chart

Onshore Chinese Yuan Price Chart

Source: Bloomberg.

Technically, the central bank has announced two guidelines for improving the USDCNY daily fixing mechanism in the future:

  • It will consider the previous day's USDCNY market closing rate.
  • It will also consider the fluctuations in major global currencies.

Most analysts in the market are also expecting that the USD/CNY trading band will widen from its current 2% to around 3%. With a more market driven currency, many analysts are expecting the renminbi to fall further in the months ahead especially in the light of faltering economic performances and possibly higher US rates in the future.

What Has Happened Since?

Currencies

Unsurprisingly, the Asian currencies were the most impacted by the devaluation - China is without doubt, a large trading partner for many countries in the region. The following table shows how much Asian currencies have weakened since 10 August (the PBoC announced the devaluation on 11 August). Compare that to the performance of EUR which has actually risen against the USD since that date.


Note: negative performance indicates the currency has strengthened.

Obviously, there would be other factors affecting these currencies besides the yuan devaluation; most notably the Malaysian Ringgit, which is beset with political woes and poor commodity performances.

Equities

Equity markets in Asia have been dragged down by the move in China. The selling has not abated even after one week with the biggest losses suffered by the Chinese markets themselves, which in turn is surprising given that a lower currency is expected to boost exports and help economic growth. China's immediate neighbors (South Korea and Taiwan) are expected to suffer as well, given that a large proportion of their exports go to China (see table below). The Taiwan market has lost 5.3% since 10 August while the Korean market has lost 3.2%. Big losers around the region include Indonesia and Singapore.

Stock Market Performances Since August 10, 2015

Importance of China as an Export Destination


Source: CIA World Factbook.

The Chinese Market: Looking For a Floor

The Shanghai composite index has fallen more than 25% since its peak in June. Despite the many measures the regulators have put in place to stem the slide, the market looks vulnerable. We have seen sharply weaker exports in recent months and slowing infrastructure investment. Industrial production growth is still weak and property starts have declined despite increasing property sales as developers try to work off their excess inventory.

What is particularly worrisome is the refusal for the economy to turn around despite the numerous macroeconomic levers pulled by the central authorities since last year, notably the interest rate and reserve requirement ratio cuts and the reforms being undertaken like the "One Belt, One Road" initiative. The huge wall of liquidity that has driven the market higher in the early part of the year has also disappeared as investors turn gun-shy after the large drop in the markets, in particular those that have arrived late to the party.

Currently, the MSCI China ETF (NYSEARCA:MCHI) trades nearly one standard deviation below its 10-year average P/E. Despite cheap valuation, there's a lingering skepticism about the market - it is cheap, but not compellingly cheap and without the economic numbers turning around, there aren't many catalysts likely to support and drive the market higher.

Going forward, what I would be looking for would be some semblance of economic and earnings growth especially in response to the various reform and macroeconomic policies that have already been put in place. Till then I find it difficult to justify an investment based on valuation at this level.

Chinese Equities: Which Sectors Benefit and Which Suffer Due to a Weaker Yuan

With the renminbi expected to fall further, the following table summarizes the main beneficiaries and losers due to a weaker yuan which you may want to put on your watchlist.

Winners

Exporters

In particular those that manufacture in China and ship to international markets

· Electronics and textiles would be good examples

· Lenovo has often been cited as one company that can benefit from the weaker RMB

Domestic tour companies

The cheaper yuan may attract more tourists to the Middle Kingdom though this is more likely the case if we see the yuan weaken much further first.

Losers

Airlines

Airplanes purchase and fuels are usually priced in USD. Consequently, Chinese airlines have much of their debt in USD.

China Southern airlines in its 2014 financial report stated that for every 1% drop in the yuan, its annual profits drops by CNY 767 million

Property

More than one-third of the sector's total debts is denominated in USD

Consumer goods manufacturers

Home appliance and beverage manufacturers have relatively high level of foreign debt

Summary

The devaluation of the Chinese yuan surprisingly did not help the Chinese market as investors took it as a sign that China is really in big trouble (which it may well be). Neighboring markets suffered as well as Chinese exporters now become more competitive.

With just a 3 percent drop in the currency so far, many analysts have forecasted weaker CNY in the months ahead. This is at the back of economic headwinds and potentially higher US interest rates.

The Chinese market, while historically cheap, suffers from skepticism and still slowing economic and earnings growth. This needs to reverse before the market looks fundamentally attractive again.

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

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.