Why Chinese Stocks Still Hold Long-term Potential

After a disastrous 2008, Chinese stocks have begun 2009 on a positive note, with the benchmark Shanghai Composite Index (SCI) up about 25% before losing some steam. However, the SCI remains up 18% this year. Compare this to the U.S., where the S&P 500 is down 16% and the DOW is off 18%. China is continuing to expand its economy, albeit at a lower pace of six percent to seven percent expected this year, but this is excellent given that other major global markets are seeing GDP contraction.

The rise in the SCI, in my view, demonstrates that China remains one of the top growth regions in the world. Heck, I would take six to seven percent GDP growth any day. China will become the next global economic superpower and will inevitably vault over Japan as the force in Asia.

In the U.S., Chinese stocks have been struggling, but the current valuations are attractive. The key is to have patience and to enter into small positions, so as not to risk too much capital. 

As many of you know, I have been a firm supporter of Chinese stocks even during the difficult times in 2008, when selling capitulation towards Chinese stocks was extremely high. And I continue to believe that China will be the place for stellar growth going forward. U.S. companies have not abandoned China. In fact, we continue to see significant foreign investment in the country across many sectors. For instance, troubled U.S. automaker General Motors Corporation (NYSE/GM) increased its outlook for China to growth of five percent to 10% in 2009, up from three percent. In North America, GM can't sell its cars fast enough despite major incentives and price cuts.

The bottom line is that China is a key component of the global economic machine, and it will need to stabilize its economy; otherwise the ripple effect to the rest of the world could be devastating. Given the economic slowing worldwide, it is not unexpected to see the demand for Chinese-made goods fall. In February, the country's trade surplus fell 25.7% year-over-year, driven by declining exports. It was the fourth straight month of declines and points to an economy that is struggling. The strong linkage of world economies -- unlike in the past when economies were more localized -- makes the current situation difficult for the world's central bankers and governments.

I continue to favor China for growth investors who have a long-term view. I still like the longer-term situation in China and believe you should have some capital invested in China, whether it is with large-cap blue-chip Chinese companies or with small emerging higher-risk stocks. Areas that we like longer-term are infrastructure and industrial. Service areas such as insurance, banking, technology and advertising will also be attractive as income levels rise.

In spite of the risk in China-related stocks, I believe it would be an error to bypass the country. Investing outside of the U.S. helps to diversify returns and add some growth potential. The key to investing in China is to be diversified. Invest only a portion of your capital in China. Besides small-cap stocks, you can also buy large-cap Chinese stocks or major U.S. companies with an expanding presence in China.

Profit Confidential

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