From a strategic perspective, numerous signs indicate that the current round of Renminbi appreciation is unlike any previous cycle in history. The underlying logic for this appreciation is driven by the foreign exchange settlement demand following the continuous improvement in the overseas profitability of Chinese enterprises, global capital's distrust of the US dollar and its demand for currencies backed by physical assets, and China's top-level policy design of imposing external "taxes" to subsidize domestic demand. Factors such as the US dollar's trend, the change in the Federal Reserve Chair, and foreign capital flows will not completely reverse the appreciation trend. Reviewing the seven Renminbi appreciation cycles over the past 20 years reveals that the exchange rate is not the decisive factor dominating sector allocation. However, during the initial stages of forming sustained appreciation expectations or when the exchange rate approaches key levels, market trading might replicate muscle memory. Meanwhile, from a cost-income analysis perspective, approximately 19% of industries could see profit margin improvements due to appreciation, and companies accelerating overseas capacity expansion experience smaller negative impacts on earnings from Renminbi appreciation. Furthermore, policy responses aimed at curbing excessively rapid one-sided appreciation trends, such as monetary easing or appropriately relaxing restrictions on outward financial investments, are more significant factors influencing sector allocation. The distinct underlying logic of appreciation compared to history suggests that allocation strategies should differ from past experiences. It is recommended to focus on three key drivers: short-term muscle memory, profit margin changes, and policy shifts. We have considered ten questions of market concern regarding the current Renminbi appreciation process for investor reference.
What are the signs indicating this Renminbi appreciation cycle is different from previous ones? We believe the current Renminbi appreciation cycle, beginning in the second quarter of 2025, is distinct from any historical cycle. Compared to the past seven cycles, this round shows several unique characteristics: the performance of Hong Kong stocks is not particularly strong, market expectations for a "East rising, West declining" economic dynamic between China and the US are not high, foreign capital continues to flow out of the A-share market, and the phased strength of the US dollar index cannot alter the Renminbi's appreciation trend. Historical experience suggests it is difficult to associate the simultaneous appearance of these signs with sustained Renminbi appreciation. These indicators also show that the driving factors and allocation rationale for this cycle differ from historical patterns, making simple extrapolation based on past experience less effective.
From a strategic viewpoint, what factors are driving this Renminbi appreciation cycle differently? First, the overseas profitability of Chinese enterprises is continuously improving, with trade surpluses generating substantial foreign exchange settlement demand. According to China Customs data, China's goods trade surplus reached $1.188946 trillion in 2025, a year-on-year increase of 19.78%, hitting a record high. More importantly, exporters' willingness to settle foreign exchange is rising. The proportion of the surplus converted into actual foreign exchange receipts exceeded 110% in December 2025, marking the biggest difference from the past. Since 2022, we estimate that exporters have accumulated approximately $1.1 trillion in unsettled foreign exchange. Once Renminbi appreciation expectations form, the repatriation of these overseas funds will become a self-reinforcing positive feedback mechanism.
Second, global speculative demand for physical assets is also increasing, partly reflecting concerns about US dollar credibility. For instance, since 2025, periods when the Crypto Fear & Greed Index trends towards fear have corresponded with rapid increases in SPDR Gold ETF holdings. Assets that generate real cash flows, like container shipping vessels, are also gaining favor from funds within the cryptocurrency sector. Amid the trend of physical asset tokenization, the Renminbi, as the currency of the world's largest manufacturer (physical production) and largest commodity consumer (physical consumption), is expected to see its intrinsic value continually reassessed in the future.
Third, China possesses the capability and willingness to "export inflation." Its foreign trade policy is shifting from merely scaling up to stabilizing supply chains, protecting profits, and controlling risks. Advantageous industries are transitioning from providing external "subsidies" to imposing external "taxes." This benefits the sustained enhancement of profitability for companies expanding overseas, increases the attractiveness of quality Chinese assets to global investors, and consequently continuously boosts the real demand for Renminbi.
Will factors like the nomination of Kevin Warsh as Fed Chair and strong US dollar expectations reverse the Renminbi appreciation trend? We believe that while Kevin Warsh, upon taking office, may promote a fundamental policy philosophy of "shifting from the virtual to the real economy," it is difficult to directly categorize him as hawkish or dovish. The combination of "balance sheet reduction + interest rate cuts" advocated by Warsh might face constraints in practical implementation. We expect subsequent policies to progress gradually rather than shift drastically. The "Warsh trade" does have a certain short-term impact on markets but does not affect the long-term logic of assets. More importantly, this round of Renminbi appreciation is fundamentally different from any historical episode. Its underlying logic—driven by the settlement demand from improved Chinese corporate overseas profitability, global distrust of the US dollar, demand for currencies backed by physical assets, and China's policy of external "taxation" to subsidize domestic demand—will not be reversed by a change in the Fed Chair or renewed strong dollar expectations. Additionally, we believe factors such as China-US relations in 2026, expectations of weaker external demand, anticipated significant foreign capital outflows, and even the monetary policy of the People's Bank of China will not completely reverse the Renminbi's appreciation trend.
What lessons can be learned from the impact of Yen appreciation in the 1970s-80s on Japanese manufacturing? The Yen appreciation of the 1970s-80s can be divided into two phases. Before the 1985 Plaza Accord, it was driven by industrial upgrades in manufacturing that spurred economic growth and currency strength. Post-Accord, it entered an uncontrolled acceleration phase. Rapid Yen appreciation directly harmed export-oriented enterprises. According to Japanese Ministry of Finance data, Japan's trade surplus in 1990 fell by 44.7% compared to 1986. Leading manufacturing firms were forced to expand overseas. Wind data shows Japan's outward direct investment expanded significantly, growing from $14.48 billion in 1986 to $48.024 billion in 1990, with its share of GDP rising from 0.28% to 1.42%, gradually hollowing out domestic manufacturing. Furthermore, the increased purchasing power from Yen appreciation boosted goods imports, and domestic demand-oriented manufacturing also faced import substitution pressures, squeezing many manufacturing firms lacking transformation capabilities out of the market.
Simultaneously, the Bank of Japan adopted a "flood-like" monetary policy to counter appreciation and failed to effectively restrict the influx of overseas hot money. A lack of real investment opportunities channeled funds into stocks and real estate, ultimately forming a vicious cycle of "industrial relocation -> capital idling -> bubble formation." Long-term consequences included the asset price bubble burst leading to the "lost decades," and the continuous decline in Japanese manufacturing's global standing. The persistent loss of market share and pricing power eventually eroded corporate profits. World Bank data shows Japan's industrial value-added share of GDP fell from 42.9% in 1970 to 28.6% currently. Lessons include succumbing to external pressure to sign the Plaza Accord, blind overseas expansion leading to industrial hollowing-out, excessive monetary easing, ineffective cross-border capital flow controls (including industrial capital outflows and hot money inflows), and failure to cool the stock and property markets promptly, which severely damaged Japanese manufacturing.
Why has the performance of Hong Kong stocks been weaker than historically during this Renminbi appreciation cycle? In the past seven Renminbi appreciation cycles against the US dollar, the CFETS spot rate appreciated by an average of +7.1%, while the Shanghai Composite Index averaged +9.1% and the Hang Seng Index averaged +17.1% during the same periods. Hong Kong stocks typically performed better during Renminbi appreciation. As of the 2024 annual reports, 49.2% of Hong Kong-listed companies use USD or HKD as their functional currency. After Renminbi appreciation, currency translation effects on profits and asset revaluation can enhance the value of these Hong Kong-listed firms. Additionally, the highly free capital market environment attracts foreign inflows, giving Hong Kong stocks greater price elasticity. However, in this cycle, the earnings of heavyweight sectors in Hong Kong stocks have been poor, and asset-heavy industries like real estate and energy have not yet stabilized, limiting the amplifying effect of Renminbi appreciation on assets and profits. Moreover, the historical trading logic of "East rising, West declining" is not mainstream in this appreciation cycle. Coupled with persistently weak profitability in Hong Kong stocks and disappointing Q3 2025 earnings from several leading internet and automotive companies, trading enthusiasm has been relatively subdued. These factors collectively explain the weak performance of Hong Kong stocks in this appreciation cycle.
Based on a review of the past 20 years, is the exchange rate the dominant factor in sector allocation? A review of the seven Renminbi appreciation cycles over the past 20 years shows that the top-performing sectors varied in each cycle. The commonality among these sectors was their ability to benefit from exchange gains, cost savings, enjoy the relative advantages of China's macroeconomic recovery, or benefit from liquidity premiums due to significant foreign capital inflows. However, over a longer time horizon, Renminbi appreciation is merely a pricing outcome or a narrative logic during specific phases and does not play a dominant role in sector allocation. Markets sometimes trade based on common-sense transmission logic during the initial stages of Renminbi appreciation or near key levels. For example, companies highly dependent on imported raw materials benefit from a stronger domestic currency reducing procurement costs and boosting profits. Such logic is easy to disseminate, understand, and accept. If an industry has no major flaws in its business cycle, the market might use this macro logic of benefiting from appreciation for short-term consensus trading. Typical industries include airlines, paper, and gas, which fall into the category of "muscle memory" trading.
From a cost-income analysis, which industries might see profit margin improvements due to Renminbi appreciation? The impact of Renminbi appreciation on industry profit margins depends on the import dependency of inputs and the export dependency of outputs. Based on 2023 national economic input-output table data, we conducted a cost-income analysis for 211 sub-sectors under Renminbi appreciation. 62.5% of industries are largely unaffected by Renminbi exchange rate movements, while approximately 19% are expected to benefit. Beneficiary industries can be roughly categorized into four types. First, upstream resources and raw materials, including: steel, non-ferrous metals, petroleum & petrochemicals (refining), basic chemicals (fertilizers, coatings, chemical fibers, plastics, etc.), building materials (refractories), electronics (semiconductor materials). Second, domestic demand consumer goods, mainly including: agriculture, forestry, animal husbandry & fishery (feed, vegetable oil, sugar), light industrial manufacturing (paper, paper products), consumer electronics, etc. Third, service-related sectors, including: power & utilities (gas), transportation (shipping), commercial retail (import-oriented cross-border e-commerce), social services (quality inspection, industrial design, vehicle & electronic product repair). Fourth, manufacturing equipment, mainly including machinery (metal products & metalworking equipment), electronics (semiconductor equipment).
How might policy responses to curb excessively rapid one-sided appreciation affect sector allocation? Stabilizing the currency and preventing the formation of one-sided appreciation expectations may be challenges for the central bank in 2026. Excessively rapid Renminbi appreciation could trigger speculative behavior and damage manufacturing competitiveness. To manage appreciation pressures, we see two broad policy approaches: First, using appropriately accommodative monetary policy to lower real interest rates. From this perspective, 2026 is a year where monetary policy could more easily surprise on the dovish side, which is significant for stimulating domestic demand sectors and pushing markets higher. Second, relaxing restrictions on outward financial investments for domestic financial institutions and even residents to some extent. This is crucial for diversifying asset allocation exposures and enhancing expected returns, and can genuinely propel the overseas expansion of China's wealth management industry. Financial sectors like securities and insurance could also unlock new growth drivers and better articulate globalization and growth stories. Additionally, industrial policies are expected to help mitigate the negative impacts of Renminbi appreciation on potentially affected industries.
Do companies accelerating overseas capacity expansion face smaller negative impacts on profitability from Renminbi appreciation? In recent years, A-share manufacturing companies have been accelerating overseas capacity expansion. From 2023 to 2025, the number of non-sales companies explicitly stating overseas investment and factory construction in their announcements was 107, 117, and 146, respectively. The profitability characteristics of these overseas-expanding firms cannot be fully explained by the "domestic production + global sales" assumption, and their currency exposure differs from typical exporters. Forming a portfolio of companies with cumulative overseas investment exceeding $100 million from 2015-2023, we found that their excess net profit growth rate relative to the all-A-share non-financial portfolio shows a more pronounced negative correlation with the USD/CNY exchange rate. The correlation coefficient was -0.42 from 2015-2019, with stronger negativity before the first Sino-US trade war. In other words, companies capable of successful large-scale overseas capacity layout typically have established significant competitive barriers in their fields, including technological leadership, efficient supply chain management, strong brands, or customer relationships. Their industrial Alpha (competitive edge) often outweighs the macro Beta (currency loss), so the profitability of leading overseas expanders is significantly less negatively impacted by Renminbi appreciation.
Overall, under sustained Renminbi appreciation, what allocation clues can be followed? If Renminbi appreciation persists, we believe allocation can focus on three clues driven by short-term muscle memory, profit margin changes, and policy shifts. The first clue is sectors driven by short-term muscle memory. Historical review shows that industries like airlines, gas, and paper intuitively benefit significantly on the cost side or foreign debt side, often exhibiting notable stock price elasticity. This has become a muscle memory, especially evident in the early stages of sustained appreciation or upon breaking key levels. The second clue is sectors driven by profit margin changes. Industries with high import dependency for raw materials and inputs, coupled with low export dependency for finished products, may see significant profit margin improvements due to cost savings during sustained Renminbi appreciation. These mainly include: 1) Upstream resources and raw materials: steel, non-ferrous metals, petroleum refining, basic chemicals (potash fertilizer, coatings, chemical fibers, plastics), building materials (refractories). 2) Domestic demand consumer goods: e.g., agricultural products (feed, vegetable oil, sugar). 3) Service-related sectors: e.g., shipping, import-oriented cross-border e-commerce. 4) Manufacturing equipment: mainly engineering machinery. The third clue is sectors driven by policy changes. This primarily refers to sectors benefiting from potential monetary easing or relaxation of capital account restrictions on outward investment. The former mainly includes duty-free, property developers (which themselves often benefit in appreciation cycles), while the latter focuses on the globalization potential of securities and insurance.
Risk Factors: Escalation of Sino-US friction in technology, trade, and finance; Further escalation of conflicts in Russia-Ukraine and the Middle East; Tighter-than-expected domestic and international macro liquidity; Policy effectiveness, implementation results, or economic recovery in China falling short of expectations; Slower-than-expected digestion of China's real estate inventory.
Comments