Monday, October 25, 2010
Traders just got the "all clear" signal from China.
Amid the noise of Apple's earnings announcement, you might have missed it. But it's a big bullish sign for Chinese stocks. Let me explain...
Last Tuesday, the People's Bank of China raised benchmark lending and deposit rates. Rates will inch up 0.25%. The one-year lending rate is now 5.56%. The one-year deposit rate is 2.5%.
Doesn't sound like a huge move. But here's why you should take note...
This is the first rate increase since the 2008-2009 global economic crisis. These "first" rate hikes are rare – they only happen when countries are coming out of recessions or similar economic stress.
There have only been four "firsts" in the U.S. in the past two decades. The last one happened in 2004, as conditions were improving after the 2001 recession. There were 16 more rate hikes over the next two years as the U.S. economy rocketed ahead. The market didn't peak until October 2007 – more than three years later.
When a central bank starts raising rates, it's a sign of confidence. You only raise rates when you think your economy is doing too well, when you're worried about inflation picking up.
No one has a better view of what's going on in China than its policymakers. If they're starting to get concerned about the economy heating up, that's a great signal that the economy will boost stocks for at least the next year.
As I mentioned earlier, there have been four occasions since 1990 when the U.S. raised interest rates for the first time. Below is a table showing how the S&P 500 performed over the following two years if you had bought on the day of the announcement.
The first thing that should jump out at you is the lack of any major pullbacks. It's not surprising if you remember these "first" rate hikes are a signal that the economy is stable and getting stronger.
While the initial market reaction was negative – Chinese stocks sold off on the day of the announcement – the long-term signal is positive.
Unlike the U.S., China doesn't have problems such as mass unemployment, a ballooning national deficit, and a collapsed housing market. And while few expect the Fed to raise rates in the U.S. before the end of 2011, China just did.
Granted, Chinese stocks have enjoyed a big run since their credit crisis bottom in late 2008. But these stocks are capable of incredible runs... It wouldn't be surprising at all to see China stocks go much higher from here, especially over the next year.
Over the summer, Larsen and colleague Frank Curzio traveled to China to scope out potential investments. "China is a lot like the U.S. was 100 years ago – an up-and-coming economy driven by hard work and the desire for a better life," Larsen wrote. "There will be booms and busts along the way, of course. But this is an extraordinary situation."
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