China Is Getting Complicated

I've been writing about China's ascending middle class as an investment catalyst since the start of this site. Quite predictably the story on the ground has been playing out either as fast we thought or slower than we thought but it is happening. The eye-popping number of how many cities are being built, how many have 1 million or more people, all the build-out connecting those cities, all the resource hoarding, all the exporting and all the buying of US treasury debt are all part of the story.

We've all known about the water and air issues for a while, the Sichuan earthquake revealed some of the humanitarian short comings, there will be policy mistakes, as mentioned the other day the country faces a serious demographic problem 15-20 years from now and the latest (that I saw anyway) is that Andy Xie has a commentary up laying out a day of reckoning that might be ten years away based on the demographics and the end, or slowing down, of "urbanization."

One point I have tried to make repeatedly is that while I unambiguously buy into the stuff from the first paragraph it is going to be a lumpy ride and will not be a one way trade. As much as I buy into it, long time readers may recall I was out for a little over a year (June 2007-August 2008). I'm in now with China Mobile (CHL) and recently I added the iShares Emerging Market Infrastructure ETF (EMIF) which is about 1/3 China/HK.

The risk factors or flaws or whatever you want to call them seem to be getting a little more play these days which is good thing. China is a great story but there are risk factors and while I do not know how many 70% declines there will be over the next ten years there will be a few that are at least 30%.

There have been more and more products created to allow access to Chinese-related stocks and there will be more including GlobalX having filed for six sector funds and EG Shares having more funds to roll out which will be heavy in China. I have been very consistent in wanting to avoid financials and export related stocks and focus on areas where money must be spent.

I recently wrote an article for theStreet about the iShares Clean Energy Fund (ICLN) which is heavy in China but just about all the Chinese stocks are solar names. Chinese solar has been popular for trading but it is possible that money will not have to be spent on solar, it may turn out that other forms of alternative energy "wins." That is not a prediction I simply don't think the world knows whether there will be a big winner here or whether there will many different technologies employed. If solar does not "win" then tech, for the most part, in China will not be a good place to be.

Above I spelled out where I want to be China-wise for the time being. Consistent with the areas where I think money must be spent could be the consumer sectors. I've not sorted this out completely I have to say but it does seem logical that as the middle class continues to grow that consumer stocks, both staples and discretionary, would do well. Of course this could also bring in soft commodities as a play on better nutrition. If Fonterra ever goes public that might be a way to benefit from improved Chinese nutrition as opposed to investing directly in it. To be determined at a later time.

A lot of the ETFs have exposure to China in areas that may not be ideal (areas I think should be avoided actually) which means that people may want to consider individual stocks. I realize not everyone will be comfortable with that but there are a lot stocks from many sectors and while poor stock selection is a realistic risk out and out fraud and a stock that goes to zero overnight is a very low probability.