Patient Investors May Benefit From China's Yuan Move

NEW YORK – China's decision Thursday to drop its currency's peg to U.S. dollar and allow the yuan to appreciate may spell good news for U.S. stock investors who are in for the long haul.

U.S. stock gauges jumped when the yuan news first hit, but they soon gave up the gains as investors focused on how limited a move it was — an appreciation of just 2.1 percent. Many analysts had been looking for a move of 5 percent to 7 percent.

"What is at stake here is China's willingness to acknowledge they have to be more flexible and more disciplined about monetary policy," said James Paulsen, chief investment strategist at Wells Capital Management (search) in Minneapolis, with $115 billion in assets in stocks and bonds.

"The support to U.S. stocks will come once terms of trade with China improve," Paulsen said. "As U.S. companies become more competitive, inflows to the country increase, with the entire economy benefiting. That is very supportive to U.S. stocks in the medium and long term horizon."

So, for stock investors with a longer view, analysts said the move provides opportunity, particularly in companies producing dollar-denominated commodities as well as those making luxury consumer goods.

"We'll be able to sell higher-end goods," said Frank Holmes, chief executive of U.S. Global Investors in San Antonio, Texas. "Their costs of buying equipment and jets will go down, all of a sudden we might see Chinese companies buying Boeing (BA) jets, and U.S. and European products — that's what they need."

China's revaluation may prompt a trend of freer exchange rates across the far east, giving holders of Asian currencies more buying power, said Abhijit Chakrabortti, global equity strategist at JPMorgan Chase & Co. in New York.

Malaysia already ended its seven-year old U.S. dollar peg on its currency following the Chinese announcement. The ringgit, like the yuan, will be managed against a basket of currencies and is expected to appreciate around 2 percent to 3 percent when trading resumes on Friday.

"The balance of power will shift from Asian exporters to Asian consumers," Chakrabortti said. "You should be bullish on luxury goods like Tiffany and LVMH where Asia is a big buyer."

On the down side, it could be a negative for shares of discount retailers, such as Wal-Mart Stores Inc. (WMT), since a higher-valued yuan will make their huge inventories of Chinese-manufactured goods more expensive. Wal-Mart shares slid 1.3 percent Thursday following the news.

Host of the 2008 Summer Olympics (search), China is on a path to massive infrastructure development that may favor raw material companies. Growth in the country topped 9 percent last year driving demand for building materials like copper, which hit a all-time record of $1.665 a pound on Thursday.

"The biggest cost item in China is commodities; commodities are priced in U.S. dollars," Holmes said. When the "yuan rises against the U.S. dollar, the costs to buy commodities will decline."

Besides commodities, the Chinese have also been huge buyers of U.S. Treasuries, which they have used to keep the yuan undervalued. Under its new currency regime, demand for U.S. bonds may slacken and that, too, may drive demand for U.S. equities.

U.S. Treasuries fell Thursday after China's announcement. The yield, which moves inversely to prices, on the benchmark 10-year note rose 6 basis points to 4.22 percent.

Foreign central banks, including China, "won't have to continue to buy Treasury securities at the same rate; and then to sell the security the U.S. government will have to sell those to other investors, and that would mean higher long-term interest rates," said Ira Kalish, director of global economics at Deloitte Research in Los Angeles.

"Yields will be dictated by U.S. cyclical factors and what the Federal Reserve does," said Chakrabortti. "You should be cautious on rate-sensitive sectors like financials and consumer discretionary."

In allowing the yuan to appreciate, China is improving the free flow of capital markets in a way that may stave off mounting tensions between Beijing and Washington that many analysts viewed as a greater threat to stocks than the currency's valuation.

"In terms of trade policy, this will give China a little bit of breathing room," said Andrew Bernard, professor of international economics at the Tuck School of Business (search) at Dartmouth University in Hanover, New Hampshire.

"It certainly takes the wind out of the sails of people in Congress who want to impose tariffs," Bernard said.