Don’t Count China Out

Submitted by Investing Daily as part of our contributors program.

Don’t Count China Out

By: Yiannis Mostrous

Double-digit growth in the world’s second largest economy is officially over. China this month reported that gross domestic product (GDP) growth slowed to 8.1 percent a year in the first quarter of 2012, down from 8.9 percent in the previous quarter.

Investors were disappointed, anticipating a milder drop to 8.4 percent. Much of the slowdown in China’s GDP stemmed from a drop in demand for its exports in key markets including the US and Europe.

Pessimism now seems to envelope the Middle Kingdom, but a more balanced view is appropriate. Despite the slowdown, China’s major economic indicators are still at relatively healthy levels. A soft rather than hard landing seems in place.

For starters, the country’s Five-Year Plan for 2011 to 2015 had called for annual long-term GDP growth of 7 percent. Consequently, investors shouldn’t have been surprised by the possibility of slower growth in China.

Price pressures are expected to remain in check, but the Chinese government could easily kick-start growth if warranted. The median forecast for inflation this year is 3.4 percent, well below Beijing’s 4 percent target. That gives the People’s Bank of China room to stimulate if necessary.

Two developments could push the Chinese to provide a fiscal economic stimulus. The first is the potential of an exogenous shock that affects the global economy. Candidates are a blow-up of the European sovereign-debt crisis, a US recession, or war in the Middle East. The second is a collapse in exports, which would lead to massive layoffs in the most populous parts of the country.

In any case, expect the Chinese to roll out a stimulus package substantial enough to cushion the blow. Any fiscal or monetary loosening in the second quarter would likely stimulate growth in the second half of the year to above-potential growth.

To be sure, Europe’s debt woes and the still patchy US recovery are dampening demand for China’s exports, but China’s leaders are reorienting the economy more toward domestic consumption and away from volatile foreign demand for manufactured goods. China is taking rigorous measures to boost household spending, steps that will pay off later this year.

China also is poised to accelerate spending this year on roads, bridges and utilities. This increased spending on infrastructure provides an additional lever, beyond consumption and exports, for the Chinese to boost economic growth.

The Real Issue: Real Estate

The most significant issue affecting China’s short-term sustainable growth is housing. Residential housing investment represents around 15 percent of overall investment in China. The Chinese leadership’s efforts in bringing down housing prices and curbing speculation have worked. For the first quarter of the year, new housing starts were down 5.2 percent year over year, while sales were down 15.5 percent.

However, the main reason for the slowdown in housing has been restrictions imposed by the government, not lack of demand. Chinese authorities don’t want to undermine the housing market over the long haul. Later in the year, they’ll probably relax housing-related restrictions that were put in place to curb excesses. Such a move would boost housing sales and construction.

The broad Chinese market is nearly impossible for foreign individual investors to tap into because of restrictions on investment and foreign capital. Most China-focused funds invest in US-listed American depositary receipts, the few local B-shares open to foreign investors, or H-shares, the Hong Kong listings of Chinese stocks.

The best way to access the local Chinese market is through the Market Vectors China ETF (NYSE: PEK). The fund tracks the CSI 300 Index, a local market capitalization-weighted index designed to capture the 300 largest and most liquid stocks. For more Chinese stock picks, check out my free report, The Best Asian Stocks to Buy Now.