Going Long China: Seeing Is Believing

Includes: FXI, GXC, PGJ
by: IndexUniverse

I was talking to a friend the other night, a nonfinancial type, but very intelligent and with quite a lot of money invested mainly in equities, and he's about 50% China and Emerging Markets in his portfolio.

It seemed completely insane to me. His basic line is that he spends a lot of time working in China and there is no doubt about it. They are blowing us out of the water on growth and will be for a long time. That's the gist of what he said, and others who I know have spent a lot of time in China have a similar story. They all say, seeing is believing. There are skyscrapers going up as far as the eye can see. An air of confidence, can-do attitude and success the likes of which the world has not seen since the U.S. in the 1950s.

Even Matt Hougan has said it — that China's capitalized weight far underrepresents its footprint in the global economy right now. But that, in part, is what makes me a little nervous. For one, you know you're in for a volatility ride that sometimes feels like Silicon Valley 1999 on steroids (sorry, that is an unfortunate Barry Bonds allusion for you Bay Area people). But the government has got its hands in a lot of the activity, the currency and markets are carefully controlled and well, anything could happen.

But it does seem to me like it's a bit of an irresistible force building. So having gone to China and seen it, it seems like the ultimate Peter Lynch story ... of buying what you know, and what you see. And I think I'm on board, but very cautiously. Is it legit to buy into China at a level greater than its capitalization? That seems fair I guess, but the limited supply of equity and casino atmosphere in China markets can send valuations to stratospheric levels that sometimes feel like they've already priced in the next Roman Empire—fans, grapes and all.

So I like China—and so do the people who have poured the billions invested in FXI. In the ETF world, you've got a couple other very good options now with the PowerShares Halter (NASDAQ:PGJ) and the SPDRs China (NYSEARCA:GXC). So China doesn't have to cost you an arm and a leg like it used to (one of my buddy's non-ETF China funds had a cool 200 bps ER attached to it).

India? This is a country with a lot going on, and there are a lot of big-time pluses, with democratic culture and English as the lingua franca at the front of the line. But somehow I'm just not convinced. You see, I've been to India. Insanely interesting, spiritual, colorful ... vibrant. Yes. Engine of capitalism? Somehow I can't quite see it. But it may be a forest-for-the-trees issue, because I do know a lot of Indians in the U.S. who are incredibly talented. So you get the feeling there's a super-elite. But there's a lot that needs to happen before you're seeing skyscrapers going up in India as far as you can see and not campfires and market tables and donkeys in the street.

Russia? You've got to be kidding. Painted rust, robber barons and a czarist government. Hard for me to see that as well. Eastern Europe, yes, I think there's plenty of room to run.

And I'd love to see Latin America rise up. What happened in Argentina is a tragedy. They were a world power in the 1950s, and should have led the continent, a continent now torn by intractable political disputes and violence. Africa? Whew. I lived there three years in the middle of the Sahara Desert. Beautiful, warm & seemingly sliding into ever-greater instability. It would have to start in the South and move through Nigeria. These are the areas where the frontier-economy investing could potentially really DO something. And you want upside? Nowhere to GO but up.

I think that this is where we'll be seeing more activity. And not just from the Bonos of the world. Already microfinance has gotten some big-league traction ... and up a couple of notches, "frontier investing" has become a new buzzword. And that's exciting to me on a number of levels. Because I think most of the world is not playing on a level playing field and the overwhelming (uh, 90% of the) global population really has no access to capital. Zero. So given a bit to run with, it could pick up and run, and in the process, provide some outsized returns to some Plan in the U.S.

So how is that for a lot of vague cultural stereotypes trying to translate themselves into a coherent investment thesis abroad? At least it's more interesting than trying to parse growth, value and style in an increasingly correlated U.S. market.

Written by Jim Wiandt