The Unlikely Winners From China’s Rate Cut

by Jim Woods | June 15, 2012 8:07 am

China was in the mood to lower the cost of capital last week, as the country’s policymakers decided to cut interest rates for the first time in more than two years. China’s central bank, the People’s Bank of China, reduced borrowing costs by 25 basis points, lowering the benchmark one-year lending rate to 6.31% from 6.56%. The new rate went into effect on June 8, as did a new rate for the one-year yuan deposit, which fell to 3.25% from 3.5%.

The move by Chinese policymakers confirms what many already knew: namely, that Beijing is committed to avoiding a so-called “hard landing” for its slowing economy. For the Chinese economy to be considered as hitting the skids and diving into “hard landing” territory, it would have to experience consistent quarterly growth below 7% for multiple quarters, and it is nowhere near that metric. The hope is that the rate cut will make sure that any slowdown will be in the form of a “soft landing” that the global markets want.

News of the rate cut on June 7 helped the market extend the prior day’s rally, which saw the Dow vault 286 points. Many traders are hoping the China rate cut will translate into additional moves by Europe and the U.S. to add more liquidity into the system. Wall Street loves cheap money — hence the boost in stocks since last week.

Now, some might think the lower interest rates will be good for Chinese industrial and banking sectors, and this is likely true. However, for individual investors looking for the biggest beneficiaries of the China rate cut, the first thing to do is look at what the Chinese consumer is buying. That’s because more money in the hands of more Chinese is going to spur more consumer spending — so it only makes sense to look at the things that the Chinese crave most.

So, what do Chinese consumers really want? In a word: luxury.

After decades of living in a communist country where conformity of thought, simplicity of garb and a paucity of personal expression was encouraged, Chinese consumers have broken out in a big way, and they want to show off their newfound wealthy status. This means well-heeled Chinese consumers — i.e., those who will stand to benefit most from the increased wealth effect of lower interest rates — will be able to purchase even more of the trendy Western fashions, latest model smartphones and luxurious leather handbags and shoes that show off their wealth.

One of China’s favorite luxury brands also is one of the world’s favorite brands, Apple (NASDAQ:AAPL[1]). In China, the Apple iPhone 4 is the smartphone of choice. Sales of the Apple iPhone were up fivefold from the prior year, and that helped Apple’s revenues in the country surge to $12.4 billion for the first half of the fiscal year. That’s nearly reaches the $13.3 billion that Apple made in all of the last fiscal year.

Another favorite luxury brand in China is handbag and leather goods maker Louis Vuitton Moet Hennessy (PINK:LVMUY[2]). For young professionals who were born in the late ’70s and ’80s, a leather briefcase from Louis Vuitton represents the ultimate in having arrived. In China’s upper-income circles, it is increasingly a social stigma for young women not to own high-end designer hand bags. Having fake bags is an even a bigger faux pas. That’s one reason why young people would rather save as much of their salary as they can so that they can spend it all on the status of a high-end purse that costs $2,000.

For Chinese consumers who merely aspire to owning an expensive handbag, there’s the lower-cost luxury option of buying a high-end drink from iconic beverage maker Starbucks (NASDAQ:SBUX[3]). Having a cup of Starbucks coffee, or some other Starbucks beverage, is tantamount to walking down the streets of Beijing with an iPhone or a Louis Vuitton handbag: it means you have achieved enough in life to buy the finest-quality items, and that you are just one notch above the others in China’s prestige-oriented social structure.

Are luxury goods the only sector that’s likely to benefit from lower interest rates? Not hardly. But if you want to really take advantage of the Chinese rate cut, forget about only Chinese-based stocks and concentrate on what Chinese consumers really want — a taste of Western luxury.

As of this writing, Jim Woods did not hold a position in any of the aforementioned securities.

  1. AAPL:
  2. LVMUY:
  3. SBUX:

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