Should I Invest in China?

I’ve had a number of Tycoon members write in recently asking about the current downturn we’ve been seeing in the Chinese equity markets.

I mean, we keep hearing about all the great things happening in East Asia, right? I even have personal friends who are currently working and living there ... and they don’t see any visible signs of a slowdown occurring.

So then, why has the Shanghai Index dropped almost 1,200 points in two months?

Well, we’ve seen a number of unfortunate market events come out of China recently:

For a brief moment, the country boasted the largest company in the world, PetroChina – the company had a market cap of approximately $1 trillion, but has since seen its valuation drop by almost one third in under a month.

Even the legendary investor Warren Buffett has already cashed out of his PetroChina holdings (for a profit, of course), citing the Shanghai market as unsustainable.

This comes on the heels of the news that the Chinese government instructed banks to freeze lending until 2008 – that means businesses, homeowners and even stock market investors who relied on credit now have NO access to new capital for another month.

If all this weren’t enough to make investors run for the hills, let’s not forget that China is facing mounting international pressure to let its currency appreciate further and faster – the latest requests are coming out of Japan, a country whose economy greatly depends on China and Hong Kong.

The country is plagued by inflation, international pressures to open its currency up which would only hurt its precious export-driven economy, and a stock market that’s dropping by the minute – so why, oh why should a US investor want to buy into such a mess abroad when we’re in a fine pickle right here at home?

Well, I’ll tell you…

As investors, we have to think like Bernard Baruch – the man who only “bought his straw hats in the winter.” That quote is from his famous analogy of buying straw hats in the winter when nobody needed one, and then selling them in the summer when the cool, comfortable headgear was in high demand. The same applies in any market ... especially the stock market.

So let’s approach this situation by assuming that China’s stock market is going “south for the winter.” Then the question becomes, will its prospects brighten for the summer?

Now, I can write all about the fantastic elements of China’s economy.

I can talk about how quickly the country is growing, or how much the Olympics will affect the business climate in 2008, or how many US companies (including the Nasdaq) are pouring millions and even billions of dollars into China’s economy. Sure, I could do that. But then somebody else could come along and completely disagree with everything I said.

So I’m not going to even discuss those things here. Because there’s one thing about China’s economy that nobody can argue or disagree with: China’s demographics!

This is a country with 1.4 billion people – the U.S. only has roughly 280 million people, so that’s about 5 times the size of our country!

Back in 1981, almost 53% of China’s population lived below the poverty line. Today, that number is under 8% - that means China has almost 500 million people who were once poor and no longer are!

That’s half of a billion people who are now part of the middle class and want to buy goods, services and products commensurate with that newly found social status. Goods like cars, homes, technology products, etc.

The aggregate demand that has been built up in this country is only just beginning to be unleashed – China is far and away the greatest wealth generating opportunity for the next 20 – 30 years!

Long-Term Opportunities
Now, is this to say that China’s market couldn’t go down further? Of course not – in fact, there’s a good chance the market will continue to correct throughout the remainder of the year.

But I’m not talking about investing in China for the short term – these are long-term factors we’re talking about here (demographic shifts, aggregate demand, etc.), and therefore, we need to take a long-term perspective when looking at this country as an investment opportunity.

So, if you have a belief in this sector as I do, then the question shouldn’t be, “Should I invest in China?” The only question in your mind should be, “When should I invest in China?”

Once the correction is finished, and the market bottoms out and begins to turn, you should definitely be looking for opportunities there. Now, I know how difficult this might sound for a U.S. investor, so I’m going to give you a bit of advice:

Buy the sector, not the stocks!

Meaning, if your time and knowledge of the market are limited, then you should avoid trying to pick individual stocks – instead invest in the ENTIRE sector. One of the best ways to do that is by looking for great ETFs. Here are two that will give you some exposure to the Chinese equity markets without forcing you to rack your brain too much looking for opportunities in company names you can’t pronounce or understand (e.g. Kong Zhong Corp.):

1. The FTSE/Xinhua 25 Index – The symbol is (FXI), and it contains China’s 25 largest H-Share and Red Chip stocks. So think of it as an index of Chinese blue chips.
2. If you’re looking to spread your bets around even further, then you could take a look at the SPDR S&P China ETF (GXC) which pretty much tracks the entire Chinese equity market.

Like I said before, think of this as “winter time” for China’s stock market. Smart investors will be loading up on cheap stocks now so they can sell them for a handsome profit when the summer comes around.

If you’d like some help in identifying market trends overall, I highly recommend taking a look at the CRISS system my colleague, Christopher Rowe, just launched. Unfortunately, the VIP pricing period has ended, but it’s still a steal when you compare it to the potential profits you could make by learning to invest like Chris.

Have a great week!

Comments

[Friedman]

From the "reliable" Wikipedia:

As of 2003, the distribution of urban household income:

Average per capita disposable income by quintile: Y 9,061 [U.S.$1,095]

first quintile: Y 3,285
second quintile: Y 5,377
third quintile: Y 7,279
fourth quintile: Y 9,763
fifth quintile: Y 17,431

That middle class will really be buying a ton of cars, homes, technology products, etc.

[laynez]

Mr. Mulligan's observations on the Chinese economy tediously echoes a theme common to many foreign journalists. It seems likely that much of the analysis of China's economy takes place from the vantage point of the Sheraton Grand Plaza in Shanghai, with those surmising being attended to by elegantly dressed hostesses serving 5-star fare and (lots of) drink. For example, where did Mr. Mulligan come up with the "only 8% below the poverty line" number? Something dropped by a government bureaucrat while he was gazing out at all the new Mercedes and Lexus sedans flying by? (most of these are assigned to corrupt officials with connections, purchased by financing schemes arranged through a banking system known to be insolvent). Mr. Mulligan, get on a bicycle and tour the countryside where at least 70% of the masses eke out an existance. Then you'll know not to necessarily believe everything doled out by the propaganda ministry. Most of the people in China outside of the showcase urban centers frequented by foreign news reporters and business analysts are indeed, actually, poor, and in no position to consume even the most basic of stuff churned out by the vaunted export machine. Add to that, the pollution in China is so dreadfully, horribly awful that many see serious social unrest as an almost inevitable result. China is not only hampered by government and business corruption, it personifies it. China will soon face either hyperinflation brought on by the artificial value of its currency, or a huge reduction in exports as a result of revaluation. And speaking of bubbles, where I live in Shenzhen (bordering Hong Kong), residential real-estate was last year hopelessly out of reach to the average working professional couple, but has more than doubled in the past year!

[Tom B]

China-- the next Enron. Look, China is an environmental train wreck. An oppressive regime with a penchant for invading sovereign nations. They sell deadly, contaminated products. And they may be doing drug manufacturing for US companies soon-- that's a tragedy waiting to happen. Why ON EARTH would you believe ANYTHING Chinese CFO's tell you? I like international investing, but like to favor countries that are at least SLIGHTLY aware of the concept of business ethics.

Look to India. More highly educated population, on average. Democracy. Better ethical standards. Already a good population of potential consumers.

[PESSIMISTIBULL]

GREATSITE

[huangthomas]

Cheng SiWei, whose warning caused Chinese stock market to fall 6.5% and sent shock wave all over the world on Jan. 31, is talking again. His latest statement may represent the official position of China.

On December 3, he gave an interview which appeared in Chinese official news agency: Xinhua net.
………………………..
Interviewer: Last Friday (November 30), Shanghai stock exchange index fell below 120-day moving average (-21.8% from the peak), are we in a bear market?
Cheng: A raging bull becomes a tamed bull, but it’s still a bull. (His word in Chinese: KuaiNiu bian ManNiu, hai shi Niu).
………………………
Interviewer: How long it’s going to last?
Cheng: I believe the bull will run up to 2008 summer Olympic.
………………………
Interviewer: How about after the Olympic?
Cheng: I can’t predict that far into the future.

??????????

[huangthomas]

Chinese middle class.

In 2005, Chinese official Bureau of Statistics defined “Chinese middle class family” as families (of 3) with annual income above 60,000 yuan, which is equivalent to $7,200 at the official exchange rate of 8.3 yuan to 1 usd. PNB Paribas defined Chinese middle class income at a higher level of above 75,000 yuan per year for a family of 3. At today’s exchange rate of 7.5 to 1, it is equivalent to $10,000 per year. With a very generous 50% PPP (purchasing power parity) adjustment, the figure can be brought up to $15,000 per year.

In the United States, the poverty line is defined in 2006 as a family of 3 with annual income of $17,170 for American living in 48 contiguous states ($21,470 in Alaska). Therefore, the official Chinese definition of “Chinese middle class” income level is way below the poverty line in the United States even adjusted for PPP. I believe Chinese have right to feel “middle class” and be happy about it, based on the definition given by the Chinese Communist Government. But, they are far from being financially free or independent. It is highly doubtful that a growing “Chinese middle class” will be able to solve the balance of payment by increasing consumption of non-commodity imports from the developed world. The middle class is poverty stricken.

[Wilson]

@Friedman - the Y3,285 allowed them to buy the cell phone and for those in this income range - they are saving up to buy a PC the following year. They won't be buying a Ford just yet. You are missing the author's point.

@User128086 - you have propaganda fanned up your other end and you don't even know it. "corrupt officials", "insolvent banking system", "70% eke out on existance", "show case urban centers" (how do you make such centers?), "social unrest", "artificial value of its currency."

@Thomas Barta - "penchant for invading sovereign nations". India has better business ethics than any other country? Explain why it takes 3-4 months to get a telephone line installed in India whereas in China its about 1 week?

[laynez]

I will stand by my comments except the one about the insolvent banking system (I'm basing that on a credible information source however.) I've taught English all over several provinces. Most of the people in China's countryside are poor. Even in the richest cities there is a tremendous level of poverty. Corruption personified--from what I've witnessed yes, although I'll certainly agree that China's system has no monopoly on corruption and may even be a runner up to the USA. Yeah...showcase is the right idea. Much of what happens in China today is for show, it doesn't have depth. Social unrest--how's over 75,000 recorded demonstrations against government corruption and unfairness in the last year alone?? Artificial value of the RMB...are you kidding? Oh, you forgot to mention my comment about pollution...

[Tom B]

"Explain why it takes 3-4 months to get a telephone line installed in India whereas in China its about 1 week?"

I can't speak to the Chinese telecom system vs India's. Perhaps they give capital punishment to slow line men. What I meant by my comment is that China has little regard for intellectual property. My perception is that India fares a little better in this regard.

[calvino]

1.4 billion people. That's a lot of people. I did not realize there were that many people. Dude, you really have some inside info. Who ever would have thought about that, 1.4 billion people. Now that is insight. You really have an ability to see what everyone else misses. The regular investor just looks for the obvious, while you uncover the hidden statistics, AND point them out. I really feel privileged, like I have been let in on a secret knowledge. 1.4 billion people, who knew, who would have ever thought to invest on that hidden theme. You are brilliant. Thanks.

[Aaronb]

Go to China and see for yourself. There is definitely NOT a middle class such as you describe. Maybe in 30 YEARS there will be.

Chinese also tend to gamble more than Westerners. That is a main reason why their stock market is so volatile. People there "bet" on stocks.

[Aaronb]

Go to China yourself and see this "middle class" you are talking about. You are on crack! Most of China is VERY poor.