China: One Big Market... and a Still-Huge Opportunity

Alexander Green
by Alexander Green, Chief Investment Strategist, The Oxford Club

Global equity investors can hardly be blamed for feeling a little down at the mouth lately.

The U.S. economy isn’t growing fast enough to absorb new laborers entering the workforce. Europe has even bigger problems with countries like Spain and Greece in full-blown depressions and the future of the 17-nation euro a question mark. And emerging economies from Latin America to the Pacific Rim are ratcheting down expectations due to softness in their leading export markets.

However, it would be a mistake to overlook the world’s great emerging behemoth: China.

Although GDP growth there has slowed from the heady 10% annual rate of the past few decades, China is still the world’s fastest-growing major economy and – get ready – it will be the world’s largest in less than 10 years.

I know. You’ve heard the concerns about real estate prices and overly optimistic construction activity in China. But there’s little chance of that country experiencing the real estate boom and bust that occurred in the U.S. and Europe.

Vacant space is filling rapidly in China. And, as hundreds of millions more people are expected to move from rural areas to the city, this won’t change any time soon. And unlike the U.S., where consumers bought homes with little or nothing down, Chinese buyers make minimum down payments of 40% on a first home and 60% on a second home. People who do this don’t mail their keys in to the bank.

During boom times in the U.S., the savings rate dropped to zero. And then went negative. Not so in China. The average citizen saves a third of his income.

And whereas the U.S. is rapidly reaching the point where the national debt will soon equal the size of the economy, China has a debt-to-GDP ratio of just 17%. That gives it plenty of room for fiscal stimulus if necessary.

Meanwhile, Chinese stocks are extraordinarily cheap on both an earnings and a price-to-book basis. There are two relatively low-risk ways to play this – and both come with a decent dividend attached.

The first is to buy the widely followed iShares FTSE China 25 Index Fund (NYSE: FXI). It holds a broad selection of China’s biggest and most profitable companies, including China Mobile, China Life Insurance, CNOOC, China Construction Bank, and China Petroleum. The average holding sells for just eight times earnings and only 20% more than book value. The average company in the S&P 500, by comparison, sells for more than 13 times earnings and two times book. Plus, you’ll collect at 2.8% dividend yield here.

Another diversified play on China is the Guggenheim China Small Cap Fund (NYSE: HAO). Here you’ll gain access to smaller and faster-growing companies in China. Hence the potential – as with small caps in the West – is even greater. The average company in this fund sells for nine times earnings and sells at a slight discount to book. You’ll collect a 3.3% dividend here.

You don’t need to go overboard here. No one would argue that China is not without its unique risks. But it also the world’s biggest development story with extraordinary opportunities for growth and income, too. These funds are lower-risk ways to capitalize on it.

Good Investing,

Alex

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