If the Renminbi starts to appreciate continuously

Factors Driving the Continuous Appreciation of the Renminbi Are Gradually Increasing, Market Attention Is Also Starting to Heat Up

We believe that investors should gradually begin to adapt to asset allocation in an environment of continuous appreciation of the Renminbi. In the first 11 months of this year, China's cumulative trade surplus reached USD 1.076 trillion, a year-on-year increase of 21.7%, setting a historical record. More importantly, the willingness of export enterprises to convert foreign exchange has been continuously rising, with the proportion of surplus converted into receipts exceeding 100% in October this year, which is the biggest difference from the past few years. Since 2022, we estimate that the accumulated amount of foreign exchange to be converted by exporters is around USD 1 trillion. Once expectations for Renminbi appreciation are formed, the return of overseas funds will become a positive feedback mechanism that continuously strengthens. In addition to long-term allocation needs, the demand for physical assets from global speculative funds has also been increasing this year. For example, each significant drop in the cryptocurrency fear and greed index (tending towards panic) has corresponded to a rapid increase in SPDR Gold ETF holdings, which is clearly not explainable by central bank gold purchases and private gold buying behavior. Furthermore, assets that can generate real cash flow, such as container ships, have also begun to attract funds accumulated in the cryptocurrency sector, with the trend of tokenization of physical assets clearly surpassing that of virtual asset tokenization this year. As the currency of the world's largest manufacturing (physical assets) and largest commodity (physical consumption) country, the intrinsic value of the Renminbi will continue to be reassessed in the future. In the short term, the significantly lower-than-expected U.S. inflation data for November has further opened up market expectations for the Federal Reserve's interest rate cuts next year, which will also strengthen market attention to the trend of Renminbi appreciation. Currently, the offshore USD to Renminbi spot exchange rate is approaching the 7.0 mark, with the 1-year, 2-year, and 5-year forward exchange rates rising to 6.90, 6.79, and 6.44 respectively, of which the 1-year forward has appreciated by 313 points since December, with the premium continuously expanding.

Decisive Factors from the 7 Rounds of Renminbi Appreciation Cycles Over the Past 20 Years

Over the past 20 years, there have been 7 rounds of Renminbi appreciation. The first round, from July 2005 to July 2008, was driven by macro factors of exports + urbanization, with the core narrative being "revaluation of Renminbi assets." The best-performing sectors were non-bank, non-ferrous metals, coal, chemicals, and new energy. The second round, from June 2010 to August 2015, saw China transitioning from a traditional economy to an emerging economy, with Renminbi appreciation combined with excess liquidity, leading to good performance in sectors such as computers, media, telecommunications, and consumer services. The third round, from January 2017 to February 2018, was characterized by a strong recovery in the macro cycle, coupled with accelerated foreign capital inflows into A-shares, with high ROE and stable core assets (food and beverage, home appliances) and pro-cyclical sectors (steel, coal, banking, real estate) performing well. Among the subsequent four rounds of appreciation cycles, the period from May 2020 to May 2021 was relatively strong due to China's leading global recovery and showcasing strong supply chain advantages, with core assets in new energy, food and beverage, and consumer services clustering to an extreme Other temporary appreciation is brought about by the repair of stage-specific economic expectations. From historical experience, the appreciation of the Renminbi is merely a pricing result at a specific stage and does not play a dominant role in industry allocation.

Some industries will perform better in the early stages of sustained appreciation expectations, and the market may replicate muscle memory.

Sometimes, the market will trade based on some common-sense transmission logic at the beginning of the Renminbi appreciation cycle. For example, companies that rely heavily on imported raw materials benefit from currency appreciation, which helps reduce procurement costs and increase profits. This kind of logic is very easy to spread, understand, and accept. If there are no obvious flaws in the industry's prosperity, the market may engage in short-term consensus trading based on the macro logic of benefiting from appreciation. Typical industries include aviation (the cost of jet fuel, components, and maintenance in USD decreases, alleviating the exchange rate pressure of USD liabilities), papermaking (the cost of imported raw materials like pulp decreases, enhancing gross profit in processing and trading), and gas (imported raw materials). However, in reality, from a longer time dimension, the profitability of these industries ultimately depends on supply and demand relationships. The appreciation of the Renminbi serves merely as a narrative logic, with limited impact on profitability.

From the perspective of cost and income analysis, about 19% of industries will see profit margin increases due to appreciation.

Based on the 2023 national economic input-output table data, we conducted a cost-income analysis of 211 sub-industries under the background of Renminbi appreciation. Industries benefiting from Renminbi appreciation can be roughly divided into four categories: 1) upstream resource products and raw materials, including: steel, non-ferrous metals, petroleum and petrochemicals (refining), basic chemicals (fertilizers, coatings, chemical fibers, plastics, etc.), building materials (refractory materials), electronics (semiconductor materials); 2) domestic consumer goods, mainly including: agriculture, forestry, animal husbandry, and fishery (feed, vegetable oil, sugar), light industry manufacturing (papermaking, paper products), consumer electronics, etc.; 3) service-related varieties, including: electricity and public utilities (gas), transportation (shipping), trade retail (import-oriented cross-border e-commerce), social services (quality inspection services, industrial design services, motor vehicle and electronic product repair); 4) manufacturing equipment, mainly including machinery (metal products & metal processing equipment), electronics (semiconductor equipment).

More important factors to curb the rapid unilateral appreciation trend.

Stabilizing the currency value and preventing unilateral appreciation expectations may be a problem the central bank faces next year. Rapid appreciation of the Renminbi may trigger some speculative behaviors, which also damage the competitive advantage of the manufacturing industry. To adjust the pressure of Renminbi appreciation, we believe there are two general policy ideas: first, loose monetary policy to lower real interest rates. From this perspective, next year is a year where monetary policy is more likely to exceed expectations in terms of easing, which is significant for stimulating domestic demand sectors and driving the market to a new level; second, to a certain extent, relax restrictions on local financial institutions and even residents' foreign financial investments. This is crucial for diversifying asset allocation exposure and enhancing expected returns, and it can truly promote the overseas expansion of China's wealth management industry. Brokerages, insurance, and other financial industries will also open new growth poles at that time, better telling the story of globalization and growth

In the context of the continuous appreciation of the RMB, attention can be paid to short-term muscle memory-driven, profit margin change-driven, and policy change-driven clues

If the RMB begins to appreciate continuously, we believe that in terms of allocation, attention can be paid to three clues: short-term muscle memory-driven, profit margin change-driven, and policy change-driven. The first clue is short-term muscle memory-driven varieties. A review of the 7 rounds of appreciation of the RMB exchange rate since 2000 shows that in the early stages of continuous appreciation, industries such as aviation, gas, and papermaking intuitively benefit significantly on the cost or foreign debt side, thus usually exhibiting significant stock price elasticity, which has become a kind of muscle memory. The second clue is varieties driven by profit margin changes. Industries with high dependence on imported raw materials and inputs, while having low dependence on exported finished products, may see a significant increase in profit margins due to cost savings during the continuous appreciation of the RMB. The main varieties include the following categories: 1) Upstream resource products and raw materials, including steel, non-ferrous metals, petroleum refining, basic chemicals (potash fertilizer, coatings, chemical fibers, plastics), and building materials (refractory materials); 2) Domestic consumer goods, such as agricultural products (feed, vegetable oil, sugar, etc.); 3) Service-related varieties, such as shipping and import-oriented cross-border e-commerce; 4) Manufacturing equipment, mainly engineering machinery, etc. The third clue is varieties driven by policy changes. Varieties benefiting from policy changes mainly refer to those benefiting from potential monetary policy easing or relaxation of restrictions on foreign investment in the capital account. The former mainly includes duty-free and real estate developers (which are also varieties that easily benefit from the appreciation cycle), while the latter mainly refers to the globalization potential of financial sectors such as brokerages and insurance.

Risk Warning and Disclaimer

The market has risks, and investment should be cautious. This article does not constitute personal investment advice and does not take into account the specific investment goals, financial conditions, or needs of individual users. Users should consider whether any opinions, views, or conclusions in this article are suitable for their specific circumstances. Investment based on this is at one's own risk