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Why I Still Like China Over The Long Term

Source: www.cia.gov

Mark your calendars for 2016.  That’s when, according to the International Monetary Fund, China will overtake the U.S.

The IMF projects that, in real terms, by 2016 China’s economy will expand to $19 trillion (from $11.2 trillion today) while the U.S. economy will reach $18.2 trillion.  And that means that China’s share of global output will reach 18%…while the U.S. share will decline to 17.7%.

This is not a new trend.  In 1990, the U.S. accounted for something like 25% of global output, and last year it dropped to 20%.  In the meanwhile, China’s share rose from 4% twenty years ago to over 13% in 2010 (according to Bloomberg).

 And China’s increasing contribution to the world’s output is accompanied by serious GDP growth.  The World Bank increased its forecast for China’s growth to 9.3% this year, and 8.7% next year (after the country reported 9.7% GDP for the first quarter).

But that growth will be met with inflationary pressure: the World Bank expects prices to increase 5% this year, and 3.4% next year.  On the upside, inflation moderated to 5.3% last month, down from 5.4% in March (and the government has taken a proactive approach to taming pricing pressures).

But there are concerns about China overheating. Economist Nouriel Roubini considers China’s high-end residential and commercial real estate investment “excessive”, and warns that the country will face “immense overcapacity and a staggering non-performing loan problem”.  And the result: “China is poised for a sharp slowdown” a few years down the road.  And Grantham Mayo Van Oterloo & Co. estimates there is a 25% chance of the country will experience “a financial stumble, a housing stumble, a stumble from rebalancing of capital spending, or any combination thereof”.

Even while forecasting the end of the “Age of America” as it is overtaken by China, the IMF warns that the country could face a ‘hard landing for economic growth’ as the result of a credit boom and banking crisis if the right policies aren’t employed.  And while the World Bank increased its growth forecast, it also cautioned that China’s real estate market is a “particular source of risk”.

All things considered, I still like China today.  It remains a growth opportunity, and on the upside, inflationary pressure may temper if, as the World Bank expects, food price increases slow over the next twelve months.  And within a portfolio of emerging markets China has performed well recently based on relative strength.

I like iShares FTSE China 25 Index Fund (FXI); the fund has skirted oversold territory after a decline that began at the end of April, as emerging markets on the whole faced a sell-off.  I am watching for a rebound, at which point shares could see some resistance around $44.50.   

Ten years ago, the U.S. economy was three times the size of China’s.  What a difference a decade makes.

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