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Chinese proverb — slow growth is better than no growth at all

China’s growth may be diminishing, but it is still a profitable destination for Canadian investors, says this advisory, which offers several buys.

“For twenty-five years after 1949, from a worldly economic perspective, China did not exist.”

That would be the era of Mao, the Great Leap Forward, the Cultural Revolution and Communism in full cry. Parading around with little red books was not conducive to business.

“World markets really only began to rediscover the country in the 1970s. For the past decade, China’s economic engine has truly kicked into high gear producing an industrial revolution the size of which has never been seen.”

Has the party stopped short due to the worldwide economic crisis? Should Canadian investors still be looking across the Pacific?

We’ll seek answers for those questions in KeyStone’s Small-Cap Stock Report. Published by an independent research firm, this advisory has covered China closely for years. It supplied the quotes above.

Having begun the week with one look at the Orient (see Daily Buy-Sell Adviser, February 23), we’ll sandwich it with another glance to the East. Is China still the world’s best hope for growth? Or is it going to take a Great Leap Backward like so many others?

We can tell you that these analysts have enough faith in the Chinese future to make several different buy recommendations.

Four sets of books

The Chinese stock markets certainly look like most of their fellow markets around the world. The country’s biggest, the Shanghai exchange, was down 66 per cent in 2008.

And since exports account for about one-third of China’s GDP, the slump in the U.S. and Europe was bound to slow down growth in China.

So this advisory asks, “is the downside trend and weakening price environment a sign of things to come or is it a great time to pick up some solid assets in the long term?”

One difficulty in answering that question is the inexact nature of economic data coming out of China. There’s an old Chinese saying. A good businessman keeps four sets of books — one for himself, one for his wife (with his extracurricular spending removed), one to show the taxman he’s not making a profit and one to show investors that he is.

And it’s not entirely a joke, says the advisory. Traditionally, many businesses have kept as many as five sets of books. “Investing in this region is not for the faint of heart,” is the advisory’s proverb.

The fastest in the world

Speaking of books, the author of the rather controversial A Random Walk Down Wall Street, Mr. Burton Malkiel, hasn’t always found favour with these analysts. But they agree with his observations on China.

First, though China’s GDP growth is slowing, it will remain the fastest in the world.

Second, if you’re a North American investor, you’re lucky to have 2 per cent exposure to China — and that’s not enough.

Third, the recent devaluations in Chinese stock prices offers “unprecedented investment opportunity.”

The advisory carries on from there. The goal of the Chinese government, it says, has been to keep annual GDP growth above 8 per cent. It was 9 per cent in the third quarter, but it’s bound to go down.

Still, says the advisory, China may be the one place in the world that can hope to offset slowing demand overseas with increased demand at home. With foreign reserves of $2 trillion, China can absorb a lot.

Compared to projected growth figures for Canada (perilously close to zero) or the United States (in the red), a Chinese rate of 7 or even 5 per cent seems “palatable.”

The fact is, says the advisory in unison with Mr. Malkiel, you’re better off with China’s declining growth than with no growth at all.

The to-do list

Infrastructure may be the latest buzzword over here. But China started a serious spending plan several years ago, well ahead of the westerners who are now desperately getting into the game.

On the to-do list in its 2006 plan — six new railway systems, 14 expressways, upgraded transport facilities at 12 ports, new deepwater channels at the mouths of major rivers, and the expansion of 10 airports.

This won’t help exports a great deal, the advisory admits, but it adds up to a lot of stimulus on the home front.

Not least, there are the banks. The Bank of China, like so many around the globe, got whacked with toxic debt. But China’s tight control of its banking system kept most of it sheltered from America’s bad debt.

For years, Chinese banks were ridiculed for being “cash-centric,” says the advisory, while Western banks basked in a credit bonanza.

“But in the wake of the credit crisis, China’s unsophisticated banks — with simple loans and limited products — looked to be running a solid business; traditional banking, where you lend money to someone who can pay it back.” What an idea!

A vital part of the economy

If China is better prepared to meet an economic slowdown than most countries, how should investors prepare to take advantage of the opportunity? This advisory has several different suggestions.

One is to buy a Chinese index fund, such as iShares FTSE/Xinhua China 25 (NYSE-FXI). You could also buy an actively managed mutual fund (it suggests a U.S. fund, the Matthews China Fund).

You could also buy multinational corporations that are spreading their wings in China, like Wal-Mart (NYSE-WMT) or Toyota (NYSE-TM).

Or you could buy a basket of Chinese stocks that trade on North American exchanges. These are stocks this research team follows closely. It has three buys that were described in detail the last time we visited this advisory (see Daily Buy-Sell Adviser, January 21).

They are fertilizer firm Migao Corporation (TSX-MGO); health care company China Sky One Medical Inc. (NASDQ-CKSI); and Sino-Forest Corporation (TSX-TRE), a major lumber harvester.

Ultimately, the advisory suggests, you don’t have enough Chinese content in your portfolio if you only have the funds and the multinationals. You need Chinese stocks that are a vital part of the economy, growing more slowly these days, but growing nonetheless.