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Why Every Investor Needs To Have a China Investment Strategy

by: William Patalon III August 08, 2008 | about stocks: FXI / PGJ    

William Patalon III

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As we’ve said time and again here at Money Morning, every investor has to have a China investment strategy.

And with the opening ceremonies for the 2008 Beijing Summer Olympic Games taking place today (Friday), this is probably as good a time as any to review the long-term case for a China investment strategy, and to look at the key factors investors should keep in mind as they put their investment plans into action.

An old Wall Street adage holds that "the trend is your friend," a precept that we wholeheartedly subscribe to. Indeed, as we’ve often told readers, the very best profit plays you’ll find will emanate from such powerful global market trends as globalization, the soaring demand for food-and-energy-related commodities, and the emergence of such new markets as Brazil, Russia, India and China.

And right now, some of the biggest global trends are being fueled by China’s white-hot economy, which is expected to advance at a double-digit clip this year - despite a global financial crisis that’s threatened to throw the U.S. economy into reverse.

But many investors are so concerned about that global financial crisis that they’re opting to avoid the volatile China market entirely, fearing there’s just too much risk within that growing Asian dragon.

Such fears are understandable: After all, the benchmark Shanghai Stock Exchange Composite Index is down 55.2% from its October peak, and was down as much as 58% - call it "double-bear-market" territory.

While "total avoidance" is certainly one form of China investment strategy - albeit an extreme one, at that - it’s not going to be a profitable one, at least not in the long term.

And the reason is simple: By avoiding China, investors are ignoring the facts - including the undeniable truth that China has become the world’s second-most-important country, and a reluctant superpower.

You need proof? Consider these facts:

  • In 2007, China contributed more to global growth than the United States - becoming the first country to do so since the Great-Depression-ridden 1930s.
  • China last year took over the top spot as the world’s largest consumer, pushing past the United States as the biggest user of four of the five most basic energy, food, and industrial commodities, Newsweek reported.
  • China’s manufacturing sector is now bigger than its U.S. counterpart, with an output value that eclipses the $2.7 trillion in annual production generated by U.S. factories - a capability that could ultimately also enable the Asian Grand Dragon to position itself as a military superpower.
  • And China is now the world’s No. 2 market for automobiles and the No. 1 producer of ocean-going merchant ships.

And this is just the beginning.

During a January 2007 speech in Beijing, economist and former U.S. Treasury Secretary Lawrence H. "Larry" Summers pointed out that Europeans who lived through the Industrial Revolution saw their standards of living increase by about 50% during their average 40-year lifespan. When industrialization spread to the more-entrepreneurial United States, living standards of the beneficiaries improved by four to five times. But residents of Asia - and especially China - who live through the ongoing "Asian Miracle" will see their living standards improve a hundredfold during their lifetimes - or 10,000%.

The wealth created from all this growth during our lifetimes alone will be enormous. But it won’t happen overnight, and it won’t occur in a straight line. Just as we’ve seen here in the U.S. financial markets, there will be periods of political and economic strife that whipsaw the values of such assets as stocks, bonds and real estate. Long-term, however, the trend is for the value of these assets to increase - and at a much steeper rate than we’ll see in any other market in the world.

That’s particularly true at a time when the United States may well be facing a Japanese-style "Lost Decade."

And that’s also why it’s crucial for every investor to have a China investment strategy.

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This article has 11 comments:

  •  
    Aug 08 02:14 PM
    I think 'the trend is your friend' refers to the actual chart of whatever stock or index you are following. It sounds like you are advising to ignore the trend in favor of a logical assessment of China's future.... If all the documentaries on the food channel, CNBC, articles in the papers, full-length National Geographics and the Olympics can't make FXI move up seriously, then, the trend is not moving that direction.

    Having said that, you spell out a nice (but obvious) case for investing in China, once the chart does turn...

    jegan ;-)
    Reply
  •  
    Aug 09 03:37 AM
    China is your classic growth trap.

    Anyway, I agree with the above poster about the "trend".
    Reply
  •  
    Aug 09 10:32 AM
    Frank Rong has written a article in SeekingAlpha that the China bubble will burst very soon. Commentator Howard9 has written about the long term problems facing China. On the other hand there is no denying the long term tremendous potential of China and its rise. Right now there is global financial turmoil and uncertainty, so the situation calls for caution. Once a definite uptrend develops, we can re-invest with greater confidence not only in China and but also the USA.
    Reply
  •  
    Aug 09 11:57 AM
    Despite dropping 56%, Shanghai A share's valuation is still in gaga-land, and Chinese accounting is highly suspicious.

    Just to throw out one bone: A share companies count UNREALIZED capital gains and losses as income.

    If you want to invest in China, do it when the overall market valuation gets cheap.
    Reply
  •  
    Aug 09 02:58 PM
    The primary reason for an investor to be in China is money flow. Money flow drives markets and Chinese money flow will only grow.
    China today has only 8% of all assets in the stock market. It's the lowest percentage in Asia and compares to a 35%-40% rate for the U.S. and Euro countries.
    The Chinese market is at bottom and money flow will take it higher for decades to come.

    Reply
  •  
    Aug 09 03:09 PM
    In regards to current valuations the Chinese market is beginning to look dirt cheap. Those that say the market is expensive are not looking at the facts.

    China Mobile trading at 11x 2009 EPS
    China Merchants Bank trading at 13x 2009 EPS (2008 EPS is still growing over 100%...some slowdown).
    Focus Media trading at 10x 2009 EPS
    Shanda Interactive trading at 9x 2009 EPS
    ...The list goes on and on.

    There has been a tremendous amount of China bashing of late and it all smells of American ignorance. There is no factual basis for the argument that China will slow. If China were to slow it would be due to the U.S. and Europe falling off the face of the earth. If that were to happen, China is the country with $1.5Trillion in reserves. China is in the position to grow through any slowdown.

    Bottom line: No signinficant slowdown coming and stocks are beginnin to look dirt cheap. If the market stays at these levels as earnings continue to grow, the market will be littered with high growth stocks trading at single digit PE's. China is here to stay, don't be ignorant of that fact.

    Good luck
    Reply
  •  
    Aug 09 03:28 PM
    Long term I'm very bullish on China.

    But short-term, I think they're going through what we went through in 2000 - Nasdaq style casino.
    Reply
  •  
    Aug 09 11:32 PM
    We all know that when an entire index drops by more than 20%, there are often a lot of small fry that get anonymously crushed. Not surprisingly then, there are a whole bunch of Chinese micro-cap ADRs with low to zero debt and trailing or forward PEs (among those with analyst coverage) in the 3X-8X range. For example:

    CAGC CHCG CNOA CPHI CYXI FUQI GFRE LTUS QXM SORL SUTR XIN XING

    In the case of these companies, the question of when China will slow and by how much is somewhat moot since they are already selling at distressed prices.
    Reply
  •  
    Aug 10 09:33 AM
    This weekend I was reading THE EDGE weekly printed in Singapore, it is a investment magazine of stocks listed in Singapore. It featured China based stocks listed in the Singapore Exchange, there are 100+ such stocks. The magazine reviewed a number of growing China stocks with excellent earnings growth but trading at pe ratio in low single digits, but the magazine chartist says even the leaders may halve from present levels. No one knows the future but the short term signals are not at all encouraging. We need to observe further to see if the trend is positive or negative.
    Reply
  •  
    Aug 10 09:43 PM
    "Why Every Investor Needs To Have a China Investment Strategy" Wow, what a title! Sounds very similar to the headlines around TMT in 2000 "Why Every Investor Needs To Have a Dot.Com Investment Strategy".
    Reply
  •  
    Aug 11 07:24 AM
    As Jim Rogers says the most important investment rule is to "Buy Low and Sell High". Probably is time to start looking at China stock markets.

    investinchinastocks.bl...
    Reply
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