By Paul Ma
McLean & Partners Wealth Management Ltd.

If you missed getting in on the ground floor in China, don't despair. Current skepticism is creating the right climate for a new move up.

        China's great economic story has been, for the most part, positive and seeded with opportunity for investors. While we expect this trend to continue in the long term, sentiment towards China has been skeptical of late. The first quarter of 2010 has seen global investors become skittish over fears that China's surging GDP could cause an economic overheating. Recent news coverage has focused on rising inflation, possible government tightening and a real estate bubble - all legitimate reasons for investors to hesitate.
        But, we see it differently. Based on our on-the-ground intelligence and evaluation of the news reports, we believe that the negative chatter actually signals an opportunity to add to positions in China.
        Our reasons not to worry:
        1. A solid government track record. We believe that the Chinese government is fully capable of managing sustainable economic growth. The growth of China's GDP in spite of global recession is a testament to the ability of China's leadership, otherwise known as the Politburo, in economic management. Its actions are not always perfect, but its track record shows a history of positive results.
        A good example of the Politburo's effective action is its response to the recent real estate bubble. As China's real estate sector has boomed, the Politburo has not forgotten the foreclosure signs and stunned faces that marked the ruinous tumble of the U.S. housing market in 2008.
        The Politburo realizes that China is not immune to a similar fate and has moved swiftly to quell the real estate rush. In a single day, it raised mortgage rates and down payment requirements. It has also instituted a 7.5 trillion yuan quota on total bank loans that should further shrink the bubble.

        2. History is a good teacher. In 2004, China's economy had seen years of high growth, similar to what we are seeing today, and word began to buzz that it was on the brink of overheating. Fearing a major downturn, the market pulled back. However, action from the Chinese government brought the situation under control, and the market subsequently turned around to continue in a longer term growth trend. We believe today's market is in a similar position. We expect a temporary market pullback over inflation fears followed by a continued up-trend as these fears are resolved.

        3. The news is not new. The fact that the media is extensively reporting on the risks of inflation, an interest rate increase and the real estate bubble means that it's probably too late for investors to do much to get out of the way. The risks have already been widely flagged and priced into the market. When China announces an interest rate increase, we should see little effect as the corresponding market correction has, for the most part, already happened. As we expect no more bad news on the interest rate and the real estate fronts, the market slide is probably nearing its bottom and looking to move back up.
        The major concern for investors should be a trade war between the U.S. and China as relations have been shaky at best. Earlier this year, the U.S. infuriated China by selling military equipment to Taiwan and then inviting the Dali Lama, the exiled leader of Tibet, to the White House, China, in turn, has angered the U.S. with its lack of cooperation on currency and climate issues.
       April 15, 2010, was shaping up to be a scary day as the U.S. was set to label China as a currency manipulator or not. Thankfully, the U.S. delayed the announcement, and the two sides have started to "play nice." High ranking officials on both sides have made friendly diplomatic visits over the past few weeks and China has hinted that it might allow the yuan to appreciate, much to the appreciation of the U.S.
        For the near future, tensions appear to have settled. We need to closely monitor the issue as an economic battle between the two heavyweights could cause a significant market correction.
        Though the Chinese market carries risks, we believe they are either priced-in or resolving. While the market may continue to trade sideways to down based on these concerns, we see an opportunity to take positions at lower prices and increase the upside from the projected long-term up-trend.
        Advertising, education and banking are sectors we believe have the potential to best take advantage of China's future growth.
        A result of China's economic boom has been the expansion of the middle class. With incomes rising, Chinese consumers are demanding luxury, branded goods. China is a relatively unbranded market so consumers have yet to be told which soft drink is "coolest" or which car will bring them status and attention. This gap has the big global names, such as Coca-Cola and Mercedes, flocking to brand their products with the receptive Chinese audience.
        Foreign ad companies such as French-based JCDecaux SA (DEC - EPA, €21.93) and online Chinese advertisers such as Sina Corp. (Nasdaq: SINA; $36.21) and Baidu Inc. (Nasdaq: BIDU; $626.19), China's largest online advertiser and search engine respectively, are set for some serious business from the rush to fill China's brand gap.

Education - a big item

        Chinese parents want the one child the government allows them to be highly successful and able to support them in their retirement. With competition in the Chinese job market stiffening, there is a growing trend among parents seeking to give their child an edge by supplementing his or her education with private lessons. Average Chinese consumers are spending over 12 per cent of their income on education, second only to food and communication/transportation.
        New Oriental Education & Tech Group Inc. (NYSE: EDU; $95.14), China's largest private-education company, is right in the middle of the country's increase in private education. New Oriental started with a focus on English lessons for adults but has expanded into a wide array of subject areas for all ages.
        We believe that companies such as New Oriental have promising growth potential as demand for education in China grows.
        China's major banks are interesting because of their low valuation. When evaluating a bank's investment value, one of the key ratios is price to book (P/B). Looking at the Industrial and Commercial Bank of China (1398 - HKG - $5.65; HKD), the country's largest bank, it has a P/B ratio of 1.5. Compared to Indian banks, such as HDFC Bank Ltd. (NYSE: HDB; $149.82) with a P/B ratio of 7.0, or Canadian banks, such as Royal Bank of Canada (TSE: RY; $61.57) with a P/B ratio of 2.63, Chinese banks are extremely cheap.
        The low valuation is not because Chinese banks are in bad shape; they are developing and lending as are Indian and Canadian banks. So why are investors staying away? Three possible reasons stem from the Chinese government's actions to cool down the real estate market, to place a lending quota on banks and to raise capital requirements for banks.
        While these factors limit what Chinese banks can do, we believe the bad news could be over and that there is an opportunity to take positions at low prices in these well-managed, well-positioned institutions.
        In China, the expression, "Don't fight the Fed," translates to, "Don't fight the Politburo." Following this mantra, heavy industries and infrastructure are two areas that should be avoided. China's heavy industry sector could see the shutdown of big polluting factories, mills and power plants as the Politburo tries to improve China's environmental record. Infrastructure could similarly be hurt as the Politburo cools the superheated real estate market with tight lending and mortgage regulations.
        Concerns surrounding an interest-rate increase, the real estate bubble and a possible trade war with the U.S. are hurting the Chinese markets. These concerns need to be closely monitored, but we believe the majority of the risks are priced in.
        The Chinese economy looks positioned for a long-term growth trend, and the current market hesitation could be a good window to add to positions at low prices.
        Editor's Note: Paul Ma, CFA, is the Portfolio Manager, International Equities with Mclean & Partners Wealth Management Ltd., Calgary, Alberta. The firm provides investment advisory services to high-net-worth individuals, trusts and non-for-profit organizations (www.mcleanpartners.com.).
       Paul Ma's article originally appeared in the Investor's Digest of Canada, 133 Richmond St., W., Toronto, ON M5H 3M8, 1 year, 24 issues, $137.