Debunking the China Myth


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Joseph L. Shaefer submits:

Globalization is seductive. And data may be presented, especially beyond the pale of strong accountancy, that creates a false confidence. In times when our own markets are more volatile, an economy like China's is particularly seductive. It seems to be on the straight-line progression the current generation of US investors enjoyed, and came to expect, from 1982-2000 (and now feel cheated that it ended, as all secular bull markets do).

I would advise caution in pursuing this investment avenue too wholeheartedly. That is not to say I would eschew international diversification! Nor that I don't own some Chinese stocks. Simply that I prefer to place the bulk of my and my clients' portfolios in nations where the rule of law trumps the rule of a central committee, where physical and intellectual property rights are respected and enforced, where nepotism and favoritism are subjected to the harsh sunlight of a free press, and where entrepreneurialism abounds alongside natural and intellectual resources. In this last I can recommend China; in the others, I fear we must tread lightly.

Here's why I recommend greater diversification: First and foremost, if the USA and the EU are the primary customers for China's products (most of which are consumer rather than industrial products) and consumers in both the US and Europe snap their wallets shut, what will power the Chinese juggernaut? They have virtually no middle class at home and their Asian neighbors often produce goods more cheaply than China does.

As importantly, Chinese workers are no different than American workers or Japanese workers or German workers. Each in their time had numerous laborers willing to work for a pittance so they could have a better life for themselves and their children. Each in turn began to demand higher wages as being only fair, given the experience and talent they gained, which leads to increased productivity.

It will be no different in China. It is actually in China's interest to pay its workers more; doing so will create the middle class that is now missing so that in future tough times, they can rely on their own consumer base to muddle through. Higher wages would make other nations less protectionist, as well. But even if neither of these revelations sinks in, it will simply happen because farm kids subsisting on rice and dried fish will move to the cities and happily labor for next to nothing for the first few years. It's new, it's exciting, you can now afford to eat meat or poultry twice a week, maybe you and your roommate even share a motorbike. But it is simply immutable human nature that the thrill wears off and you'd like chicken three times a week or you'd like to have your own motorbike. The pressure to increase wages genie is out of the bottle and there's no putting it back in.

I add to this volatile mix simmering ethnic strife; horrible air and water pollution; a lack of fresh potable water; poor corporate governance standards; the need to create 24 million new jobs a year; an aging population with no social safety net; a banking system that is used for political goals and therefore instructed to loan where politicians decide, not where responsible bankers decide; and a statist government that engenders false reporting from the hinterlands by its draconian punishment of those who fail to deliver. With this tsunami just over the horizon, I don't see a straight-line progression of success for China.

There are certainly some well-run companies there and I own some of them. CNOOC ( COO ) seems to be a fine company that meets international reporting standards, as are many others. I have even speculated in China - we own Shun Tak Holdings [SHTGY], the biggest ferry operator from the mainland to the newer, bigger Las Vegas on Macau - a play on gambling and the Chinese love of same.

But for me, the best way to play China is via other nations that have what China wants and needs: Canadian timber, Australian oil, Singaporean markets, and US grain all leap to mind. In these places, I can enjoy good corporate governance and the rule of law, yet still benefit from China's growing needs by buying quality companies in nations I am more comfortable will experience significantly less upheaval. I'll discuss some of these firms in the coming weeks. When you see them, see if you don't agree that you can profit from China's growth without taking on China's potential problems…

Disclosure: Long SHTGY, have been long other China stocks in the past and likely will be again. But prefer to play "China growth" via those companies from nations that supply China with what it needs to keep its economy going.

Disclaimer: As Registered Investment Advisors, we see it as our responsibility to advise the following: we do not know your personal financial situation, so the information contained in this communiqué represents the opinions of the staff of Stanford Wealth Management, and should not be construed as personalized investment advice.

Past performance is no guarantee of future results, rather an obvious statement but clearly too often unheeded judging by the number of investors who buy the current #1 mutual fund only to watch it plummet next month.

We encourage you to do your own research on individual issues we recommend for your analysis to see if they might be of value in your own investing. We take our responsibility to proffer intelligent commentary seriously, but it should not be assumed that investing in any securities we are investing in will always be profitable. We do our best to get it right, and we "eat our own cooking," but we could be wrong, hence our full disclosure as to whether we own or are buying the investments we write about.

See also Trading the Stealth Momentum Shift on

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing

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