China for Cheap

 | Jun 28, 2012 | 3:30 PM EDT  | Comments
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Stock quotes in this article:

FXI

,

GXC

After two months of selloffs (interspersed with a few fleeting rallies), a lot of asset classes are much cheaper than they were just a short time ago. Pricing multiples have dropped essentially across the board as investors have sought safe haven amidst a sudden spike in risk-aversion.

Chinese stocks are a bargain right now given the long-term potential and relatively low risk of that market achieving significant economic expansion during the coming decade.

Present worries, however, are trumping future potential. Anxiety over slowing growth in China is pushing down prices, despite the fact that long-term expectations for economic expansion remain extremely robust. The focus on immediate risk exacerbates short-term volatility but effectively puts expected future growth on sale. While Europe and North America continue to struggle, China has already become the world's most important economy and is on track to become the largest economy in the world.

China is currently experiencing some bumps in the road, but it's still in the easy gains portion of the growth curve. While recent revisions to growth forecasts have disappointed some investors, they still point to a prolonged period of expansion that will far exceed the developed markets of the world. The impressive demographic factors at work, including a rapidly expanding middle class, are unlikely to let up at any point. Chinese stocks across the board are poised to benefit from an increasingly wealthy population that is eager to spend on protein, cars and electronics.

China ETFs are perhaps the best example of bigger not being better. The fund that represents the lion's share of assets in this category, iShares FTSE/Xinhua China 25 Index Fund (FXI), is a very poor tool for achieving longer-term exposure. Heavy allocations to financials and mega-cap stocks diminish the connection to the truly compelling components of China's economy and instead leave investors with overweight exposure to state-owned companies.

The better option in my opinion is SPDR S&P China ETF (GXC), which features greater balance and depth of holdings. GXC now has a forward-looking P/E of below 9x, a surprisingly low multiple given the strong growth potential (earnings are expected to grow at a clip of close to 15% over the next few years).

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