Investing In China For Your Retirement? (FXI)

By: ispeculatornew
Date posted: 10.26.2011 (5:00 am) | Write a Comment  (4 Comments)

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China has clearly been a very volatile market in the past few years and very often, that has been marked by important declines. That is bound to happen over and over in China but I would still argue that China should be a significant portion of your holdings if you have a long term horizon. My main point would certainly not be that it will be a smooth ride but rather that it is almost certain that over 30 years or so, the Chinese market will rise more quickly than US and other markets If that is the case, wouldn’t you want to have at least 25% of your holdings in China?

Am I crazy to think that even holding 30-40% of my assets in China could be a great decision?

I’ve written about my convictions regarding Chinese internet stocks but I think that Chinese stocks will also tend to overperform significantly over the next couple of decades.What makes me think that?

Economy will grow rapidly: You might know that stock markets do not track the economy, especially in the short to medium term. However, as the Chinese economy overtakes the US and becomes the focus point of the world economy. I agree that on a GDP per capita basis, China will still remain well behind most industralized nations but in a nation of 1.3 billion people, the best performing companies are certain to do well. A company such as Baidu has the potential to be at the center of ecommerce in China, and many more leaders will emerge over the next few years. I would argue that the explosion of the economy will lead to incredible profits for the market leaders in dozens of different markets. Those are the companies that you want to own.

No debt: China and other emerging economies have one big difference with other leading economies, they have basically no debt which in a world where Europe and the US are becoming increasingly fragile. China will have incredible opportunities to buy valuable assets from desperate nations in Europe and abroad. I think it will also help China invest at home to help those companies that will be able to create jobs.

Attractive Valuations: Because of the fact that few investors currently hold Chinese assets and that the risk (especially for those investing with a shorter time frame) is more important, the valuations are much more attractive. For example, the forward P/E of Chinese stocks is below 10 while US markets continue to trade at a 13 forward P/E or so. Over time, as China becomes more established, that difference will narrow and the earnings of Chinese companies will no doubt increase much faster than US ones.

Solid dividend yields: While US companies have generally been decreasing the portion of their earnings that they pay out, companies in emerging markets continue to pay out high dividend payouts making them very attractive for dividend investors. If you compare at FXI for example, which invests in the 25 largest Chinese companies to the Dow Jones Industrial average (30 blue chip US companies) you will see:

FXI: 3.88%
DIA: 1.87%

That is a staggering difference and the difference is comparable if you take broader indexes. I’ve talked many times about the benefits of international diversification and clearly China would be near the top of the list of places that dividend investors should look for.

Less exposure to European banks: If you have been following the news lately, you will remember that many of the largest banks in the world have been very volatile because of their direct and indirect exposures to sovereign bonds. Take the example of Morgan Stanley which does not hold huge positions in Greek bonds but it has large interests in French banks that do have those exposures. That has caused Morgan Stanley to be highly volatile. Emerging countries banks and China in particular tend to have much smaller exposures to the type of issues that the world economy is currently facing.

Strong currency: The Chinese Yuan continues to be under the radar in terms of world trade although it is quickly gaining importance. The US government has made it crystal clear that it thinks the Yuan is massively undervalued but the Chinese government is looking to let its currency appreciate only very slowly over the years so that it can adapt to a stronger currency. That will have a very big impact on all Chinese assets that will also benefit from this appreciation. Add to that the fact that the Yuan is likely to slowly become a second “reserve currency” which will also add tremendous pressure upwards and I can only imagine how much more the Chinese Yuan will be worth 10 or 20 years from now.

Tomorrow, I’ll take a look at different ways to invest in China

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4 Comments

  1. Comment by awake — October 26, 2011 @ 12:59 pm

    Funny… I just started a ROTH yesterday and bought some FXI shares as part of portfolio.

    I’m glad to see you’re optimistic about it.

  2. Comment by Intelligent Speculator — October 26, 2011 @ 6:09 pm

    @awake – Haha, so we see eye to eye, hopefully we’re not wrong:) I would really stress that it is a very long term trade in my opinion, I would not be shocked if FXI performed badly one out of three or four years.. but overall a great play

  3. Comment by Andrew — October 26, 2011 @ 10:50 pm

    Your contention that the Chinese government has no debt is true at the national level but recently, many newa articles have mentioned China’s large provincial and municipal debt from over investment in fixed assets and projects. Also the Chinese banks have issues with bad loans and had to be recapitalized in the past so it is not like the Chinese economy poses no risks. There is the potential for civil unrest due to the authoritarian CPC regime, there is a potential real estate bubble especially in Hong Kong and currently, inflation is running particularly hot.

    However, over the long term, better growth prospects and low valuations will probably be positive for investors but over the last few years, it has been a pretty bad investment.

  4. Comment by IS — October 27, 2011 @ 3:59 am

    @Andrew – Thanks, all very good point, and yes there is certainly a potential for many tough times, especially if such events occur, but I think over the long term most of these issues are still not enough to stop China from “taking over” as the world economy leader.

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