Investing in China: Now, Later, or Never?

I will preface this entire discussion by saying I am not an expert on China. I do not know a word of Mandarin (or Cantonese for that matter), I do not know the names of more than 25 Chinese companies, and I have never been there. I do, however, know a fair amount about Chinese history and Chinese economic development. As there are a few of you that know more about certain aspects of China, I welcome your input.


Of course, when any economy is growing 11% a year, there is a great temptation to want to invest in that country's markets. With China, where the economic prospects seem so favorable, this is particularly true. However, historically the Chinese stock market has proved a treacherous mistress. For most of the ten years leading up to 2006, Chinese stocks, measured by the CSI 300, did not do particularly much of anything even while the economy boomed. Then, between 2006 and early-2008, Chinese stocks increased nearly six fold, one of the most powerful rallies by a major economy's markets in history. Then, over the next ten months, stocks fell 73%, wiping out most of the gains of the past three years. Over the ten months from October 2008 to August 2009, stocks rallied by better than 100%, out-pacing most other markets. 


Since then, however, China has been an unusually poorly performing market, even rivaling some of the troubled European markets. The CSI 300 has fallen from 3,750 in August to 2,762 now, making it one of the few bear markets anywhere in the world. Its best proxy listed here, the iShares FTSE/Xinhua China 25 Fund (FXI), has badly trailed the S&P 500 over 
the past year. Despite all of the talk about China being a better place to invest, the
markets have said otherwise:

The reason for this under-performance is not entirely clear. While it is difficult to 
ascertain what Chinese companies are actually earning, it would seem that most 
Chinese stocks are fairly priced if not undervalued.Some believe that the weak
market is a sign of a bursting bubble in China driven by concerns over rapidly
advancing property prices. One cause, I feel, of the chronic weak link between 
Chinese stock prices and economic performance is the uncertain nature of 
property rights in China. Fundamentally, buying a stock is buying a stake in 
the equity value of the company. If this link is uncertain and there are doubts 
about your legal recourse in the event of liquidation and your rights to vote on 
the future of the company, stock values will suffer. I do not believe this is the
 main cause of the current malaise in China, but I believe it to be one possibility. 


Another chronic problem with China is that the economic data do not seem to be 
particularly reliable. Conspiracy theorists may say the same about our data here, but 
in China that is a very real problem. This is not entirely surprising given that modern 
economic measurement in China is barely two decades old while it has been honed 
over the course of 80 years here. Still, the problem with this is that it is very difficult 
to determine when there are inflection points in the Chinese economy or where 
structural weaknesses may be.


Now, most importantly, what does all of this mean in terms of investing? The 
fundamental debate regarding investing in China has been do you play it directly by 
buying shares in Chinese companies through their U.S. listed ADRs or do you invest 
in companies that sell a lot to China? China is a massive importer of both capital
goods and raw materials and these sales are real, unlike some Chinese economic 
data series. This means companies like Bucyrus International (BUCY) and 
Vale (VALE).


For those interested in the massive number of Chinese ADRs, here is a list: 
Chinese ADRs


I am agnostic on the debate for now, though I lean heavily in the direction of 
playing companies that trade in more open capital markets with more mature 
financial disclosure. What do you all think?


Regardless, I think this will be on ongoing debate for some time.