News Analysis date published New: 
Monday, December 3, 2012 - 08:30
New Date created: 
Monday, December 3, 2012 - 08:30
New Date last updated: 
Monday, December 3, 2012 - 08:30

How to Profit from China's New Phase of Explosive Growth

Monday, December 3, 2012 - 8:30am

China is one of the final great economic frontiers. Its oxymoronic mixture of communism and state-sanctioned capitalism has created a colossal economic engine that had been, until recently, on a sharp upward trajectory. But I don't think the growth story is over. In fact, thanks to recent reform, I think things are about to pick up and provide investors with a second opportunity to profit from Chinese equities.

It was 34 years ago when Deng Xiapong started opening China to the world. Since then, the Chinese economy has grown an average of 10% per year, becoming the second-largest on Earth in 2009, only behind the United States.

Today, China is the world's largest exporter and the second largest importer with the most substantial foreign exchange reserves. So it's not hard to understand why investors everywhere watch that economy attentively. Problem is, this dramatic growth has recently slowed.

Fearful of an out-of-control economy, the Chinese government exercised its heavy-handed powers with a series of steps designed to squelch that rapid growth. This resulted in an economic slowdown during the last seven quarters.

But now that China has a new Communist Party leader -- Xi Jinling, who will be the face of the country for the next 10 years -- the tide is likely to change for the Chinese economy. Jinling has already stated that China will stick to policies designed to sustain long-term economic development and double its gross domestic product in the next decade.

Even the old leadership has realized the economic slowdown has gone too far. During the past year, the country has been working on the right mix of policy and free-market dynamics to stop the drift lower. Indeed, slashing interest rates twice in 2012, lowering bank reserve ratios three times since 2011 and applying multiple liquidity injections appear to be turning the tide.

The Chinese Purchasing Managers Index just moved above 50 for the first time since October 2011. Readings above 50 on this closely-followed index indicate economic expansion and below 50 are reflective of contraction. In addition, year-over-year industrial company profits surged more than 20% in October. This is a huge increase when compared to September's 7.8% gain.

What's truly a sure sign of pending explosive Chinese growth is that country's effort to formalize private lending, which would put money into the market in a more controlled manner. The country is already taking action to implement a set of financial reforms to end the underground lending and shady financial transactions that happen throughout the main Chinese cities.

All of these recent events have caused overall valuations of Chinese equities to bounce from all-time lows, creating the perfect time to enter the market. About $3 billion worth of cash flowed into Chinese exchange-traded funds (ETFs) during the month of October alone, one of the highest inflows in three-years.

If you want to get a piece of this burgeoning market, then here are two ETFs that fit the bill...

1. iShares MSCI Hong Kong Index ETF (NYSE: EWH)
This is a cap-weighted ETF that is primarily invested in banks, utilities and property companies. The ETF's price has been climbing steadily higher since mid June with resistance hit in the $19 area. Looking at the daily chart, a clear double top has formed in the $19 range, creating substantial technical resistance.

My trading strategy for this ETF would be to wait for a breakout close above $20 prior to entering long. I would not be surprised to see this ETF at $27 before the end of 2013.

2. Matthews Dragon Century China Fund (MCHFX)
Boasting what may be the coolest moniker ever for an ETF, this greater China ETF has a 40% exposure to Hong Kong firms, an 8% investment in Taiwanese companies and the remainder in Hong Kong-listed Chinese companies. The underlying assets lean toward mid-cap firms, with financial and state-owned companies underrepresented in the mix. The ETF's price has been climbing higher since the end of July but has just started a pullback, creating a value-zone buying opportunity. I like this ETF at the current level with stops at $22.25 and a $28 18-month target level.

Risks to Consider: Despite the appearance of a turnaround in China's economy, the nation still faces substantial headwinds. The slowdown in Europe and the looming U.S. fiscal cliff can have a profound effect on China due to the interconnectivity of the economies. In addition, it's critical to keep in mind that the economic numbers from the Chinese government may not always be accurate and rather released for public relation/political purposes. Always be sure to use stops and position size properly when investing.

Action to Take --> After many years of outstanding growth, China's recent economic slip made many investors scared. But the country is about to begin another phase of incredible expansion, thanks to its new leadership and market-friendly financial reform. As such, I like both of these ETFs as long-term holdings. The EWH is best purchased on a break out close above $20. The MCHFX is presently in the value "buy" zone.

David Goodboy does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.