Yuan Flexibility - Big Rally for U.S.-listed China Stocks Coming?

In a surprise move, the People's Bank of China announced yesterday that it will increase the Yuan's exchange-rate flexibility from Monday on, effectively letting the Chinese currency appreciate (and depreciate) against the U.S. dollar. Such a move had been widely expected, though the announcement came as a surprise just one week ahead of the G-20 summit. Experts expect the Yuan to appreciate about 2-5% against the dollar in the next 3-6 months.

Monday morning should be very interesting. We will see how the domestic markets in Shanghai react on the news. I would see anything less than a 2% gain for the Shanghai Composite (SSE) as a disappointment, given that the index tested 2010 lows just last Friday. But what should be even more interesting to see is if market sentiment for Chinese stocks listed on U.S. exchanges will come back strongly. Here are several very good reasons why being invested in China stocks might not be the worst of all ideas when the Chinese currency appreciates:

• U.S.-listed companies report in U.S. dollar, although most of their assets are yuan-denominated. Those will be worth more in U.S. currency.
• Chinese companies with operations primarily in mainland China will generate revenues and earnings almost exclusively in Yuan. Those will be higher now when reported in U.S. dollar.
• Net importers of raw materials from overseas will benefit from lower cost with a stronger local currency.
• Companies will benefit from a higher purchasing power of consumers and to a stronger extent corporate domestic customers.
• U.S.-listed companies often have dollar-denominated debt which will be more manageable.
• International investors will find yuan-denominated businesses more attractive again.

Many, if not most of the U.S.-listed China stocks should get a boost from this weekend's accouncement, however there are some industries where an appreciating Yuan could be seen as negative. Most notably exporters and generally Chinese companies that generate the majority of revenues in U.S. dollar. There is a chain of companies affected with companies supplying parts or services to exporters likely facing margin pressure as well. Personally I would also avoid steel and real estate and focus on consumer stocks, energy, agriculture, food and coal.