The Golden Dragon: Chinese Market Booming While Wall Street Falters

Sept. 12, 2007 Special to ABCNEWS.com — -- In more than a few backyard barbecues across the United States over Labor Day weekend, families and friends got together to share good times and stories over a few cold beverages and grilled meats. They probably talked about the weather, the baseball pennant races and the kids going back to school.

When discussions turned to finances, the lousy state of the real estate market probably got a lot of play, and so did the bumpy ride in the stock market this summer. Those who were lucky enough or smart enough (or both) to have invested in Chinese stocks earlier this year (or sooner) had a big opportunity to gloat, if they were so inclined.

All one has had to do to be successful lately is to be "in the game" financially when it comes to China. Shrewd stock-picking really has not been necessary in order to make some serious money, although it can help nicely to juice your returns.

But is there still time to buy into the Chinese growth story, or does getting in now only mean that you're setting yourself up for the crash of yet another investing bubble? Well, that depends on how you play China, since you can do so from many angles and on several different exchanges.

Perhaps the best single source of exposure to China has been the exchange-traded iShares FTSE/Xinhua China 25 Index, a basket of some of the biggest and most liquid Chinese companies. Year-to-date through September 4, the FXI was up 37.11%, compared to a gain of about 6.3% for the S&P 500 Index. This comes after an 83.2% return for the FXI in 2006.

But just because the FXI is an exchange traded fund, don't get any foolish notions here about diversification. According to Morningstar 59.8% of the fund's assets are in the top 10 holdings. The concentration in the behemoths of the Chinese domestic economy, many of them (ironically) owned at least partially by the communist government in Beijing, has been a good thing over the past year.

Big FXI component China Life Insurance is up 170% in the past year; Hong Kong-based China Mobile Limited has doubled since last September. PetroChina is a relative laggard with a 31% return over the past year.

As in all markets, if you want more return, you need to take on more risk, and in stocks, that means moving away from big blue chips and focusing on smaller, rapidly growing companies. One fund that has done this extremely well is Oberweis China Opportunities. It's up 42.29% year-to-date, and surged 81.2% in 2006. The fund has benefited from stakes in names like advertising company Focus Media Holdings and search engine and Internet portal Baidu.com. With names like Trina Solar and Suntech Power Holdings, Oberweis China also has exposure to the confluence of China and another hot sector--alternative energy.

Manager Jim Oberweis, who is also editor of the Oberweis Report newsletter, relies on a team of four analysts in Hong Kong and China to ferret out stocks that meet his growth-at-a-reasonable-price criteria. His preference is for the H-shares of Chinese companies listed in Hong Kong, since companies listing there have more stringent reporting requirements than companies' A-shares traded on the mainland exchanges. He still likes Baidu, Focus Media and CTRP.

"The local markets in China--Shanghai and Shenzhen--are pretty much unhinged from the fundamentals by any stretch of the imagination," agrees John Christy, editor of Forbes International Investment Report. Christy still sees opportunity in a country growing GDP consistently at about a 10% annualized rate, but he prefers a volatility buffer through indirect plays.

"Stocks like Nokia, Ericsson and Diageo are all multinationals, reasonably valued, and all have China exposure helping to drive future earnings growth," he notes. Another option he likes is to invest in China via Taiwan with the iShares MSCI Taiwan Index. "While obviously not a pure play, this is a great way to get exposure to world-class tech companies and China at one time," he says.

For investors who can take the sometimes wild ride, he recommends China Medical and China Mobile.

Carl Delfeld, editor of Chartwell ETF Advisor , has long been a China bull. He's optimistic that Chinese investors will now be allowed to invest in markets outside of the mainland.

"Chinese regulators will now allow Chinese investors to open accounts at Bank of China and trade securities listed in Hong Kong," says Delfeld. "Major beneficiaries of this change will be Chinese and Hong ETFs which contain H-shares," he adds, noting that EWH, FXI, and GXC are most popular ETFs with H-shares.

"The vast majority of Chinese savings is now parked in bank accounts with negative real interest rates and it is likely that at least some of this cash will take advantage of this relaxation of controls, especially since Hong Kong shares trade at an attractive discount to mainland markets," says Delfeld.

Some skeptics of China believe that the bull market could come to an end next year as spending on infrastructure ahead of next summer's Beijing Olympics slows dramatically. In addition, such a tangible event could also mark a psychological pause for the rapidly evolving Chinese nation.

"I'm skeptical that something that everybody thinks will happen will actually happen," says Oberweis.

"Chinese consumers aren't buying cellphones, computers, medical equipment and Johnnie Walker Black because they're excited about the Olympics rolling into town," says Christy. "They're doing it because they're moving up the economic food chain and that's a much more important, much longer-lasting fundamental trend that will stay in place for years to come, Olympics or no Olympics."