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Putting one and one together of China's currency move

|Includes: Baidu, Inc. (BIDU), FXI

In what may appear as a victory for US and Tim Geithner specifically, china today announced its intention to let the renminbi float more freely against a basket of currency. However, the range is still kept at plus or minus 0.5% daily. I am not at all surprised by this move for two reasons: First and foremost, it seems like a symbolic move to me than a real move. Second, it looks like Chinese government is trying to appease the local public by letting the Yuan appreciate a little bit so that economy has less inflationary pressure in the short term.
However, these constant intervention in today's markets by central banks are putting investors at a huge risk. The reason is simple, long term investors make their decisions based on analysis focusing on assumptions about a company's revenue and its cost of capital. These regular interventions by central banks give rise to confusion about those assumptions and result in more volatility. Looks like central banks have become more short term market focused around the world rather than being focused on long term growth of their respective country's economy. This sea-change started from market focused actions of Greenspan during his term at Federal Reserve and that trend has now spread to the whole world with faster speed of information these days. For example, low earning people in India are reeling under intense inflation pressure but central bank there is reluctant to make any large rate moves due to market concerns. What these economists at central bank don't understand is that markets are governed by valuations. And irrespective of their moves market may still find itself overvalued and go down.
Given the cyclical nature of growth, I think market still looks to go down. The reason is simple: people don't buy a house every year, a car every month and a laptop everyday. So by making predominantly easier policies, we can move the future demand around to today in the hopes of stimulating the economy. But it makes the danger of future shortfall even more exacerbated because demand is not evenly spread out.
I believe that we had much higher growth until 2008 due to loose policies and given the cyclical nature of economy, we are not going to get the real demand back until end of 2011. Central banks should understand these limitations and not try to intervene unnecessarily. Irrespective of their moves, market will eventually reflect these fundamentals and current path for it is go down as analysts trim down their earnings expectations. According to my analysis, S&P500 will have to go down to at least 850 before earnings expectations are aligned with fundamentals for next 2 years.
Current move by China to let the Yuan move will hurt Chinese stocks quite a bit as most companies will find it more disadvantageous than beneficial to them. But as I had written in my earlier blogpost, central bank in China was really running out of the options to prevent asset bubbles in the country. While it will help in identifying the fundamental strength of the economy, I believe that emerging market economies are solely reliant on developed economies. Most of the local demand is due to increased earnings of local people from export driven industries. So the "real" fundamentals are much weaker than most investors would like to believe.
I think with more interventions from central banks, market will go down even more as we try to manipulate demand. This will make the recovery even more prolonged and painful. I would ask investors to keep taking money off from the market as it makes upside moves because market is prime for huge downside move as valuation aligns itself with economic reality.
Technical chart below shows that S&P500 is hitting the upper envelop of (20,2) Bollinger band and RSI is getting again into over-bought category. This means that next big move for S&P500 will be a huge down move to 1000 in the short term.

Any short-term increase in import prices of US companies will put even more downward pressure on their earnings as they will find it increasingly difficult to pass on the price increases. So S&P500 looks more overvalued now.Specifically, I would be selling Chinese stocks if People's Bank of China really lets renminbi move. BIDU is highly overbought and with an over 100 P/E ratio it's a sell candidate. Shorting China ETF (NYSEARCA:FXI) is a good option for the medium term, specially if it makes any up-move in the aftermath of PBC's announcement.

Disclosure: No position at the time of writing