Investing in China: Handle with Caution

Beijing-Shanghai High-speed Railway Begins Test Run
ChinaFotoPress—Getty Images SHANGHAI, CHINA - MAY 11: (CHINA OUT) A CRH high-speed train leaves Shanghai Hongqiao Railway Station during its test run on May 11, 2011 in Shanghai, China. After 3 years construction, from April in 2008, with total investment estimated at 220.9 billion yuan (around 32.5 billion U.S. dollars), the Beijing-Shanghai high-speed railway begins a one-month trial operation. It is expected to start operation in June this year, with the travel time between the two cities reducing to five hours from the previous 10. (Photo by ChinaFotoPress/Getty Images)

Wall Street hyper-focuses on how fast China will grow this year or next. As it became clear to me on a recent visit there, my first in five years, that’s the wrong question.

I canceled my flight from Beijing to Shanghai to try out the high-speed train, which covers 811 miles — the distance between New York and Chicago — in less than five hours. Amtrak would take 19.

Five years ago Shanghai was too smoggy and under too much construction for me to understand what China’s urban transformation could mean.

To enter the city today is to be transported to a future of massive skyscrapers connected by superefficient subways. Those buildings are filling up. In 20 years, more than 350 million people will have moved from the countryside to cities.

This first-rate infrastructure now supports the world’s second-biggest economy. The real question to ask about China is whether its leaders will act as if that’s what they’re managing rather than relentlessly pursue export growth on the backs of a cheap labor pool.

Related: How to Invest in a Natural-Gas Boom

Ann Lee, author of “What the U.S. Can Learn From China,” argues the answer is yes. “They know that they need to put money in people’s pockets,” she says. As evidence, Lee points to China’s 800 million cellphone users and the 6 million students graduating college each year.

Reforms, yes, but…

Financial reform, such as expanding the role of private capital in the banking sector, is slowly taking hold. Michael Hasenstab, of the Franklin Templeton Fixed Income Group, wrote recently that this could “elevate China from a middle-income to a high-income country” over the next decade.

Yet Shanghai’s stock market trades at one-third its 2007 peak. Concerns remain about political reform, rampant bribery, intellectual-property theft, and the opaqueness of government data.

Those issues make the bull case uncertain. As Canadian scholars Alan Huang and Tony Wirjanto have observed, Chinese stocks carry price/earnings ratios similar to U.S. stocks yet with much higher growth potential.

Too bad you can’t trust the numbers and Chinese stocks are so volatile.

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That suggests a conservative approach. A standard diversified portfolio would have about 30% of stocks overseas, and a quarter of that in emerging markets. Your allocation to Chinese stocks would be about 1.4%.

Until China is more transparent, don’t get much more enthusiastic. Still, what can be seen is amazing. Leaving Shanghai, I rode the magnetic levitation train (no wheels or tracks) to the airport. It compresses a 45-minute drive to eight minutes. That’s progress.


How to Invest in a Natural-Gas Boom

Jupiterimages—Getty Images/Comstock Images Close-up of gas pipes and valves

A funny thing happened on the way to the green energy revolution: Fossil fuels came charging back into fashion.

Slow economic growth that tamed enthusiasm for alternative energy, plus Canada’s success pumping oil out of the sand, made the U.S. take another look below its feet. What’s there is natural gas. Lots of it.

The new economics

We’ve known for a while about huge gas deposits encased in shale. In the past five years, though, huge advances in horizontal drilling — going deep into shale, and then turning and drilling sideways — combined with hydraulic fracturing (“fracking”) have changed the economics of gas recovery.

And while the media have focused on the potential environmental impact of fracking, as the technology improves, even more gas will become accessible.

These new discoveries have driven natural-gas prices way down, to an average of $2.43 per million British thermal units in the first half of this year, from nearly $13 in June 2008.

Stephen Leeb, an energy expert and research chairman of Leeb Group, a financial newsletter publisher, expects the price to at least double over the next few years, but commodities future markets are too speculative a place to play for individual long-term investors.

Follow the pipeline

Rather, think about the beneficiaries of a gas boom: utilities that buy what is, even at double today’s price, a cheap, clean way to generate electricity (especially compared with coal); industrial users of energy; and pipeline and drilling-equipment makers.

Leeb recommends the FBR Gas Utility Index Investors Fund HENNESSY GAS UTILITY INDEX FUND GASFX 0.58% , an exchange-traded fund with a five-year annualized return of 8.7% and a 2.4% dividend yield. It adjusts holdings based on how much of a company’s business is connected to natural gas, so you’re not simply investing in energy firms that have a natural-gas play.

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Don’t let today’s low gas prices scare you, says Leeb. The fund is largely made up of distribution firms, which benefit from rising demand. “This is a conservative way to play the gas boom,” he adds. The biggest holding, Kinder-Morgan, is a pipeline firm.

Low prices are unquestionably a boon to industrial companies, though they also need a low dollar and an improved global economy to thrive. Those are big “ifs,” but optimists can modestly increase exposure to industrials via an ETF.

Jim Awad of Zephyr Management recommends Industrial Select Sector SPDR INDUSTRIAL SELECT SECTOR SPDR ETF XLI 0.04% . “It’s weighted toward aerospace, defense, and transportation,” says Awad. “If you think a renaissance in U.S. energy will make U.S. manufacturers and exporters more profitable, this is the perfect vehicle.”

XLI’s five-year annualized return is just 1.5%, owing to the 2008-09 recession; its three-year annualized return is a more energetic 20%.

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