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China Moves Aggressively to Push Stock Prices Higher
By Tony Sagami

September 23, 2008

Over the last six years, the Chinese central bank had been focused on cooling down its red-hot economy and fighting inflation by repeatedly increasing interest rates and reserve requirements at Chinese banks.

How repeatedly? How about 18 straight rate increases!

Not any more. For the first time in six years, the People's Bank of China (the Chinese equivalent of our Federal Reserve Bank) reduced interest rates. China's key lending rate will drop from 7.47% to 7.2% as well as reducing bank reserve requirement by a full 1% to 16.5%.

After 18 rate hikes, you can just imagine how enthusiastic Chinese investors are over the news. And for good reason too.

The drop in lending rates and bank reserve ratios will provide a strong base of support of Chinese asset prices --- both stocks and real estate --- as well as stimulate the Chinese economy. Lowering interest rates will lower the cost of business borrowing and the cut in reserve requirements will reduce the funding costs for banks.

The biggest benefit of this turnabout in monetary policy isn't cheaper money but the clear signal that the Chinese government is going to stop pushing the exchange rate of the renminbi higher.

Congress has been aggressively pushing China to raise the exchange rate of its currency against the U.S. dollar but the higher Chinese renminbi has been killing Chinese exporters but now that monetary policy has switched from tightening to loosening, the renminbi is almost certain to reverse course, start to decline, and give its exporters a gigantic boost.

Let's connect three very important fundamental dots in China.

DOT #1: The Chinese economy has slowed but only slightly. Chinese GDP has increased by double-digit rates for five years in a row and has grown by 10.1% in the first six months of 2008. That's a little off its 11%-plus rate of last year, but China is still growing by a very healthy pace.

DOT #2: The Shanghai Composite Index is down by 60% from its November peak. That big decline has pushed the valuations of Chinese stocks from very expensive to very cheap. In fact, I think the valuations are dirt, dirt cheap compared to the pace of economic growth.

DOT #3: The about-face in monetary policy is akin to throwing gasoline on a smoldering fire. Now that the Chinese stock market has the interest rate wind at its back, the new path of least resistance will be upward. I've been waiting for a catalyst to catch the Asian markets on fire and we now have it.

While the aftermath of the AIG/Fannie Mae/Freddie Mac/Bear Stears/Lehman Brothers meltdown may not be over and I cannot say with 100% certainty that Asian stocks have hit bottom...but I think we're darn close. That makes this a very opportune time to add some Asian spice to your portfolio.