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By Carl Delfield

Last week, we looked at the big picture on why raging China bulls should temper their short-term expectations. We discussed why China’s growth could sharply slow dashing expectations of eternal double-digit growth. This, in turn, could send markets into a tailspin.

Today, we look at some recent cracks in the China story and then get to the important part: What should investors do about it?

  • The myth that a China IPO could never fail went bust last week as an already launched offering for auto part manufacturer Nanning Baling was scrapped after it failed to attract bids from the required 20 institutional investors. Shares of Renren (NYSE:RENN), the hyped (and unprofitable) Chinese version of social networking leader Facebook, are in a tailspin since its May debut. Renren fell by more than 10% last Wednesday alone.
  • Last week, China became the largest energy consumer in the world, and the social costs of 10% growth are coming home to roost. My friend Elizabeth Economy’s new book on China’s environmental disaster, The River Runs Black, hit Amazon’s top-10 list on the day it was published.
  • Battered by soaring material and financing costs, the head of a small Chinese manufacturer and exporter of eyeglasses recently chased two Reuters reporters from his office crying, “This business is not tenable anymore… we are quitting!”
  • Li & Fung, which handles about 4% of American retailers’ imports from China, stated that average costs for goods rose 15% in the first five months of this year compared with the same period last year.
  • Coach (NYSE:COH), the luxury handbag manufacturer, recently announced that it would try to reduce its reliance on China to less than half of its products within four years, from 80% now, by moving production to Vietnam and India.
  • Sales of cars, minivans and sport utility vehicles grew only 7% in April from a year earlier. This signals a further slowing after year-over-year sales growth of 20% to 120% each month in 2010.
  • After a month-long investigation into local government liabilities, Beijing determined that local governments borrowed approximately 10 trillion yuan ($1.5 trillion) and some anticipate that up to 25% would go bad.
  • In nine major cities tracked by market-research firm Dragonomics, real-estate prices fell 4.9% in April from a year earlier. Last year, prices rose 21.5% in those nine cities.

Stay With China – Manage the Risk

The above list alone could easily send investors in China scurrying to the sidelines, but that would be a great mistake. Every country has its challenges and these are really just the flip side of opportunities. When pessimism is highest, the smart investors find a way to stay engaged and manage the risks.

Here’s a few ideas to stay engaged while coping with China uncertainty.

Beneath the headlines, there are plenty of Chinese companies surging ahead with eye-popping growth in sales and profits. For example, China’s environmental disaster means big bucks for companies with solutions. Put together a basket of Chinese and western firms that will profit from cleaning up the mess. Consider investing in Chinese growth indirectly to lower risks.

  • Aberdeen Indonesia (NYSEMKT:IF) has become the world’s largest exporter of thermal coal on the back of exports to China.
  • The iShares MSCI Singapore Index (NYSEARCA:EWS) sits in the center of the Chinese growth train.

Most importantly, when you invest in a Chinese ADR or exchange-traded fund (ETF), always (and I mean always) put in place a 15% trailing sell stop order. This limits your downside risk but also allows you to lock in hard earned gains if the share price pulls back after making a nice advance.

It’s important that this happens automatically so that your emotions don’t get in the way. How many times have you seen your hard-earned profits disappear after rationalizing that a falling stock will “bounce back?”

Finally, never let one country dominate your global portfolio, no matter how right you think you are. Always ask yourself the magic question: “What if I’m wrong?

Source: Investment Strategies for a Volatile Chinese Market