2 Economies, 1 Country: See Which Chinese Stocks Rise Faster!

Rudy Martin

Yes, I know — China’s growth is slowing down. That’s what everyone is saying, anyway.

Yet, curiously, plenty of people seem to be making money right now from the growth that supposedly isn’t taking place there!

You won’t get bored to distraction here by another litany of things going wrong in the Asian nation.

That’s because I recently made a discovery about how to make money from the very powerful trends taking place in China … simply by tracking a couple of ETFs that hold Chinese stocks. And if you look at two very distinct investment trends I’ll tell you about today, you’ll see it too.

The truth I discovered about the current Chinese economy — one that you can apply to other areas and over time as well — is that …

There are Really 2 Chinese Economies

And 2 Chinese Stock Markets!

No, I’m not referring to the Shanghai and Shenzhen stock markets, but instead two very distinct classifications of equity investments.

And depending which one you pick can make a world of difference in the types of returns you can make …

One of these investments has been stagnant for at least the past half year, but another portion of the Chinese stock market is still alive and vibrant.

More significantly … this condition exists in other parts of the world and will persist over time. In other words, once you see what is happening in China, you can easily spot a similar dynamic in just about every other market!

Earlier this year, I began to notice that a China-focused ETF, the PowerShares Golden Dragon China (PGJ), was routinely posting positive results. At the same time another China-stock ETF, the SPDR S&P China (GXC), like the Chinese economy, had become stagnant.

PGJ has ballooned 23.1% over the past six months while GXC has slumped 0.9%. Even with the depressing Chinese economic news over the last two months, PGJ has vaulted 17.3% vs. a meager 3.0% dead-cat bounce by GXC.

We see profit in these conditions — when an economic bifurcation occurs and one sector stalls but another branch shoots higher.

This isn’t just a passing phenomenon. I believe this can provide opportunity for a long time to come.

Most recently, on Friday, June 14, markets around the world were uniformly bad. So, it wasn’t altogether too surprising that GXC sank 2.59% that day. And given PGJ’s relative outperformance compared to GXC, it’s also no wonder that it eased only 0.77%.

So even on a bad day, the divergence held, with the Dragon fund close to 2 percentage points better than the mainstream China fund.

This bifurcation of the Chinese market has held up with surprising consistency for several months and even stayed intact on a bad day like Friday, when someone might have expected tech stocks to get hammered.

So, Why the Difference in the Performance?

It all comes down to the components of each of these funds  …

Source: Morningstar & fund cos.

Although both funds invest in broad portfolios of Chinese stocks, the sector breakdowns speak volumes about how to approach the Chinese market.

Here are the big differences:

GXC is stronger in the industrial sector and related cyclical areas such as energy, materials, financials and utilities. Meanwhile, the appropriately named PGJ “Dragon” ETF is heavily invested in information technology, telecommunications, healthcare and consumer discretionary stocks.

So, Here’s My Big Discovery  …

Investing in the Present vs. the Future!

The broader stock market portfolio represented by GXC is best described as INDUSTRIALIZATION  …

 …  While PGJ represents an attribute of today’s China best referred to as MODERNIZATION!

This explains the difference between the negative six-month return of GXC and the impressive 23.1% gain of Golden Dragon over that same period.

Consider that on the Industrialization side of China:

  • The crucial export sector been softening.
  • A slowdown in heavy industry has resulted in lower demand for materials, energy and utility usage.
  • Labor-intensive, lower-skilled manufacturing jobs are migrating from China to Asian nations with lower wages such as Bangladesh and Vietnam.
  • Much of the bank lending has been to weaker, less-efficient, state-owned industrial businesses rather than to the more-profitable technology sector.

But on the Modernization side of the world’s most-populous nation:

  • A rapidly expanding middle class is embracing technology.
  • The expanding affluent and middle-class populations have more disposable income to buy discretionary consumer goods.
  • As incomes grow, spending on healthcare and education tend to increase even faster.

The performance of PGJ’s top 10 holdings, seen in the table below, underscores how investments in China’s evolution to MODERNIZATION have been paying off while investments in its INDUSTRIALIZATION have gone nowhere  …

PowerShares Golden Dragon China ETF (PGJ)

Component Stocks

Source: Morningstar

Nine of the 10 biggest PGJ holdings have rocketed higher over the last six months.

Much of the improvement in these Modernization investments took place during the past two months — right in the face of a boatload of bad news.

Where was all that bad news stemming from? The Industrialization side of China’s economy.

In fact, six of the 10 component stocks in PGJ jumped more than 40% in half a year.

And these startling gains came from an economy that the conventional wisdom says is weakening!

2 ETFs, 2 Strong Messages

About One Dynamic Nation

The performance differences between the PGJ and GXC ETFs was not due to portfolio managers making inspired or disappointing stock picks. The funds passively track different predetermined Chinese stock maket indices.

GXC reflects the S&P/Citigroup BMI China Index, a market-cap-weighted gauge that measures the investable universe of publicly traded companies domiciled in China, but that are also legally available to foreign investors.

PGJ’s portfolio mimics the Halter USX China Index, which is comprised of the U.S.-listed securities of companies that derive a majority of their revenue from the People’s Republic of China. Obviously, the Halter USX China Index is tilted steeply toward the Modernization side of China.

The purpose of this discussion isn’t to recommend any particular Chinese stock or ETF. But I feel strongly that you need to become aware that hugely consequential lessons from the “China-bifurcation” can be used to significantly amplify your present and future overall investment returns.

3 Lessons the Modernization vs.

Industrialization Debate Can Teach Us

Lesson 1 — Don’t write off a region, country, economic sector or industry just because of negative economic reports.

The Industrialization aspect of China’s economy is almost certainly softening. But you have seen that the Modernization side of that nation’s economy appears to be very healthy.

Lesson 2 — Dig below the overall economic analysis of a country. Is it poised for Industrialization but still behind in developing a middle class and achieving Modernization?

If so, invest accordingly. Luxury goods aren’t likely to sell well in a country where most workers are still at subsistence income levels.

Lesson 3 — Big investment profits are possible if when a nation is identified in the early stages of Industrialization. But that stage of development is subject to ups and downs caused by factors such as raw material prices, currency fluctuations, global interest-rate changes and business-cycle variations in the country’s trading partners.

But catching the early stage of a country’s Modernization period can be more rewarding. Internal demand from the emerging middle class and newly affluent groups generate income that elevates even more of the population into consumers able to make more discretionary purchases.

It is a self-perpetuating process from which extraordinary long-term investment profits can be generated.

In my Global Trend Trader service, I selectively target both economic-development attributes.

For countries in the Industrialization stage, companies such as building-materials providers fit the bill nicely.

For regions where economic growth has produced a critical mass of affluent and middle-class consumers with discretionary income to spend, some of our Modernization recommendations focus on technology, luxury goods, travel and better medical treatments.

Just keep in mind that, when you hear about China or any other nation that’s simply not growing as quickly as many might expect or hope, there’s always a bull market somewhere that is fueling the overall growth engine. And that’s where you want to be when "everyone else" realizes they’ve been focusing on the wrong place all along!

Best wishes,

Rudy

 

Your thoughts on “2 Economies, 1 Country: See Which Chinese Stocks Rise Faster!”

  1. Rudy:
    This is an excellent article, as I find most all of yours are. I look forward to mid-week when you usually have something for us to digest in the hard, cold, world of investing. I can’t spend a lot of money on services but when I can, perhaps I will try your service; I am certain if I followed your direction, I would not be disappointed, even as in the past, I have bought your recommendations and made money on them. I know the service would be so much better especially not just buying, but selling which is equally important.

    Thank you for sharing wisdom with us who are readers seeking advice in the financial realm of life.

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