Should I Invest in China?

Includes: FXI, GXC
by: Wayne Mulligan

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 (NYSEARCA: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 (NYSEARCA: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!