Tag Archives: Stocks

Renminbi Valuation

The renminbi is pegged to the US Dollar, and has been for a long time, so what would a revaluation of the Chinese currency mean? Without an exchange rate determined by the marketplace, how can we anticipate the magnitude of the difference between the pegged rate and the appropriate market rate?

It is clear that the yuan is cheap relative to the dollar, but by how much? Our economies are different, and these differences lead to different relative pricing, but looking at a variety of prices can give us some sense of purchasing price parity.

Unskilled Labor:

Textile workers in China are paid about 1/30 of the amount paid for equivalent work in the United States. If this ratio were to equalize through currency revaluation, the yuan would increase by 3000%. However this is almost certainly too high, as China has an oversupply of unskilled labor. This number provides the high-end boundary on the scope of the question.

Gold:

Gold can be purchased in yuan At the time of this writing, $442 worth of gold costs 3670 yuan, implying an exchange rate of about 8.303 Yuan/$. If this ratio were reflected in the currency echange rate, the yuan would increase a negligible amount (Because the exchange rate peg is currently 8.27 Yuan/$). However this is almost certainly too low, as it is illegal for chinese citizens to invest in Gold. This number provides an low-end boundary on the scope of the question.

Basket of goods:

Depending on the basket you select, purchasing price parity implies different undervaluation of Yuan. I estimate approximately 40% undervaluation, clearly with different classes of goods and services.

Trading:

Under a fair and open market, I envision a 40% inflation on Cinese imports would greatly imporove the stature of US companies that have been drowning under Chinese import competition. Similarly, Chinese companies that earn their revenues from Chinese will see a US Dollar denominated revenue increase of 40%.

[UPDATE 1/25/2005]

Senator Lindsey Graham, (R) Judiary Committee and

Senator Charles (Chuck) Schumer, (D) Finance Committee

are announcing bill to impose a 27.5% tarif on Chinese imports, implying their view that the Renminbi is near 27.5% discounted against the Dollar.

[END UPDATE]

Let’s speculate that Chinese currency will reflect market forces within 2 years. In this speculative possible environment, investors might benefit from:

underweight Chinese companies with revenues largely based on exports

overweight Chinese companies with revenues largely based in China

underweight US companies who import from China

overweight US companies who compete with Chinese imports

Now let’s speculate that Chinese currency will remain pegged to the US Dollar. In this speculative possible environment, investors might benefit from exactly the opposite positions.

How can the US exploit a currency peg that is clearly an unfair trade practice?

Cut taxes and issue more debt.

This increases the Federal deficit, diminishing the value of the US Dollar, and also increases the after-tax pay rates for US workers.

The Myth of Negative Sentiment

Today’s article in Barrons: “The Myth of Negative Sentiment” took the position that negative sentiment in the investor community is a myth, and that the media is unnecessarily sugarcoating economic problems.

I think the article missed the point.

The sugarcoating is not for the investor crowd, it is for everyone else. Investors stand to do well as we move toward an “ownership society“, but the non-investor class is disenfranchised and falling further behind. I’m talking about the concentration of wealth and the distribution of consumption.

The article talks about how investors are heavily invested in equities rather than cash, and how this is a signal of investor optimism. This is true; it is because dividend and capital gains rates have been cut in half (or more) and interest rates on cash accounts are almost zero. Why hold cash when the yield curve is steep and tax rates are so favorable? After-tax investment returns look very promising.

But if you live paycheck-to-paycheck (Barron’s readers might not have any contact with these people…) then your prospects are grim. In the past, debtors could count on inflation to depreciate their past sins. But these days, deflation threatens to put them deeper in debt while giving the wealthy more buying power. Meanwhile social services are being cut and the lions share of tax breaks are going to people making capital gains and receiving dividend income. For them, the whole country is becomming a company town.

The issue is not negative sentiment on the part of investors, but rather social depression. And that is no myth.

XML Standard for Business Reporting / Accounting

TechWeb reports in this ARTICLE on Edgar Online‘s support of XBRL, an XML standard for companies to publish and distribute financial reports.

Such a standard would be a strong movement in the direction of efficient valuation and pricing of fundamental business characteristics. Arbitrage pricing theory could be applied using each XBRL tag as a factor, resulting in the ability to calculate values and sensitivities for stock prices based on changes to the underlying fundamentals in detail.

Cointegration improvements

Cointegration typically uses the price information for two related securities, and provides relative value signals. As with traditional technical trading strategies, changes to the fundamentals create a risk of bad relative value signals. With 2-security cointegration, this risk is doubled because changes to the fundamentals of either company can skew the relative value signal. However, this problem can be cut in half by creating baskets (portfolios) of securities and running the cointegration analysis with each security against the basket. This effectively generates signals which are skewed only by changes to the fundamentals of the individual security. Additionally, the required correlation matrix for the permuted set of security combinations can be replaced by a single vector of correlations – greatly improving calculation efficiency and extending the analysis processing potential.

To improve upon normalizing data to % changes, factors typically associated with beta may also provide better signalling data. For example, as the size of a company grows over the course of a few years, its price volitility may fall. Similarly, as market cap grows, the price change correlations may increase relative to larger cap baskets and decrease relative to smaller cap baskets.

By backtesting, optimal trigger strengths and bet sizes can be measured, however, given the correlation coefficients, volitilities, number of positions, and risk preferences, probabalistically optimal bet sizes may provide better results.

Invest in Biotech and Information Sciences

If we invest heavily in biotechnology and information services companies (especially genomics, networked centralized computing, neurology, neural network predictive applications, and nerve regeneration) in the next 50 years, many currently living people may have an opportunity to achieve substantially improved and lengthened quality of life and indefinitely extended sentience.

It’s more than a financial return, but it can still be evaluated financially. The return on these investments should be calculated as the return on the securities themselves, plus the return on your other investments over the period of time that your life and investment horizon are extended. It is possible, then, that the net return on biotech and information science investments may be substancially higher than the direct value change for those investment securities.