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One Good Investment & One Bad Investment

Nov. 20, 2014 3:34 PM ETFXI, ASHR, GLCN, SJNK
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We'll start with the good - China. In an effort to stimulate investment into Chinese companies their government has made investing in the countries A-shares open to foreign investment. Now don't expect a huge rush of money to come flowing into these A-shares because the government put limits on the amount of money that can come into the market, but look for a long steady gain in these shares. The last time China made a push to get foreign investment was in 2006. At that time, the newly released FXI went from 17 to 72 in less than 2 years.

That's over 300%. The A-shares went up even more approaching 600% gains. However, many American investors were left out as there wasn't an A-share ETF back then you could invest in. Luckily for you there are two main ETFs today you can invest in. Deutsche Bank's ASHR is the most heavily traded, but Market Vectors also has one with the symbol PEK. Both of these funds invest mostly in the CSI 300 Index which tracks the largest 300 companies with these A-shares.

The Chinese government is serious about attracting investment and they are even running ads on television and in the newspapers encouraging their citizens to get invested in these markets. I'm skeptical of many governments and their effectiveness to push policy, but the Chinese government gets things done with ruthless efficiency. I would not bet against them.

Many people think that China's growth is slowing down and while that's true, they have gone from 12% yearly GDP growth to 7% yearly growth this year, they are still growing faster than all other large countries. China's President Xi has stated that he is comfortable with this kind of growth and will not do anything as long as this 7% growth remains. I believe many of the growth concerns are overblown and the selling in this market is overdone. If the US was growing at 7% a year we would all be piling into US stocks with reckless abandon. Why is China any different? Consider adding either ASHR or PEK to your portfolio before more people catch on that China is still growing like an adolescent boy.

The bad investment I would urge everyone to consider exiting out of is junk bonds. Many investors have gotten into junk bonds in the past few years to get a much needed boost to the yield in their portfolio. This has worked because of the Fed's easy money policies and the economy has been recovering. But if the Fed needs to tighten or if the economy slows down many of these companies issuing junk bonds will get into trouble. Defaults have been at multi year lows but defaults can jump quickly like in 2007-2008.

According to this Bloomberg article, we are starting to see the bottom of the junk market deteriorate and this is reflected in the price of the short term bond ETF SJNK.

I would fully expect to see investors sell their junk debt soon as the market has been good for a long time and this sector will be hurt by the Fed raising interest rates. And no one wants to be left holding the bag when the market starts to decline.

I don't think investors have ever made money in the long term buying junk bonds when they yielded 6% because the historic default rate is around 4%. So you're really not going to be making 6%, but even if you get 50% for a liquidation value, you're only making 4% on these junk bonds. If that's not enough to scare you away from taking this unnecessary risk investing in junk bonds historically after having several years of below average defaults the default rate has jumped to over 10% a year. That would destroy the value of your junk bond portfolio.

Generally if you want to make money you need to avoid trades with low upside but high downside. This is reward setup is currently what junk bonds offer. If you must be in fixed income I would recommend short term treasuries for now or even consider getting your yield from conservative dividend aristocrat stocks.

Analyst's Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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