Why Chinese Stock Indices Make Sense

As the S&P500 and other US indices have been reverted back to 2002 levels, the FTSE/Xinhua China 25 Index is holding steady at near 2006 valuations. There are many good reasons for why China is a much better investment than any domestic fund.

Huge Differences between the US and China

The difference between China and the United States could best be described as night and day. The economic differences create the largest disparities, as capitalism meets with a still-communistic economy slowly making its way to a free market. However, the differences also extend to socio-economic disparities, as millions of Chinese live on less than $2 per day, which is less than one seventh of the maximum food stamp amount in the United States. The United States is clearly more developed; however, as an investor, that is not a benefit, but actually a disadvantage.

Large Caps?

The Xinhua China 25 represents some of the biggest names in China, as does the S&P500 in the United States. The S&P500 by nature categorizes the largest names, as it is allocated by market cap. However, the China 25 index is comprised of Chinese large caps, which look paltry when compared to American competitors. Chinese large caps are growing at rates inconceivable to American investors who would better describe Chinese stocks as aggressive growth, rather than large capitalization stocks.

Large Caps and Large Growth

Chinese stocks benefit hugely from the natural economic gain that occurs in a developing nation that enjoys a trade surplus. While corporations in the United States struggle to maintain positive organic growth rates (growth rates excluding acquisitions), Chinese corporations have the benefit of an economy that is growing at a near 10% annual pace. When the economy is growing at such a rate, a large cap that produces just 8% per year should be considered poorly managed and out of touch. The growing middle class in China is buying more and more consumer oriented products, such as cell phones. China Mobile continues to grow at a 22% rate, even with a saturation of 40% of the market. How are those numbers for a growing large cap?

The Chinese Ride Has Only Begun

Speculative investments may lead you to think that the Chinese stock markets were merely a bubble, and surely they were before the global credit crunch and economic slowdown sent investors fleeing otherwise safe Chinese stock holdings. At this point, China is selling for the same pre-bubble prices, even as corporations are healthier and better looking on paper than they were when the bubble began. The bull-run in 2007 will look like a blip on the radar as China maintains its growth rates of 10% year over year, and the country continues to export consumer products and important huge stockpiles of foreign reserves.

The Growing Political Powerhouse

Chinese relations with the Obama administration are uneasy at best. The new Treasury Secretary of the United States stated that he believed China has and is manipulating its currency, repeating the same approach that John Snow took against China some five years ago. Since that time, the Chinese have become a more important political and economic figure, as they finance many US government programs through treasury auctions and other debt sales. The negotiating power ultimately rests in the hands of the Chinese, who have the power to sell off more than a trillion dollars in US debt in the case that American politicians aim for a revaluation of their local currency.

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