Bullish on China's Stimulus Package

For years, the Chinese funded the U.S. debt fueled spending spree by heavily investing in our economy via U.S. Treasury bonds. On November 10, the tides turned when China announced it would be spending $586 billion to invest in its own country. The plan was warmly welcomed by the market and since the unveiling, the Shanghai Composite has risen some 20%.

But is Premier Wen Jiabao's stimulus package strong enough to lift China out of this global recession, achieve its target of 8% growth this year, and keep the Chinese market rally alive?

A promising plan
In contrast to the U.S. stimulus packages that have created much controversy, China's efforts look very promising. Sitting amid piles of cash, the country is fiscally strong enough to finance the anticipated expenditures. And as a country that is still in the middle of transforming itself into a more modern and industrialized nation, significant development is needed.

China's leaders wasted no time in getting down to business. In January and February of this year, they increased total fixed investment by 30% year over year. Railroad investment tripled in the same time frame. And Chinese banks lent more in the past three months than in the previous twelve.

Still, the real challenge still rests in the hands of the Chinese consumer. China is a production powerhouse economy, but its consumers are conservative spenders and the country leans on its exporting activity for growth. Consequently, the global financial crisis and consumption cutback from its major importers has left a deep hole in the economy. Filling this hole is necessary for the country to achieve economic recovery and to further decoupling from the rest of the world. In other words, China's leaders must transform the economy from an export-driven one into a more self-sustaining system.

Spend, China, spend
Premier Wen outlined a strategy targeting this notion earlier this month when he addressed the National People's Congress. His plan calls to raise the proportion of national income that goes to wages, and ultimately increase consumption in areas such as culture, recreation, tourism, and the Internet. This won't be an easy feat since the Chinese maintain a high personal savings rates and are notoriously reluctant to spend frivolously, even during prosperous booms.

However, I think Wen's plan has potential to propel China out of the downturn. And before you call me a hypocrite for cheering on China's stimulus plan, as I've publicly opposed the U.S.'s stimulus plans, let me explain.

Threefold rationale
First, while China is on its way toward building a similar economic model as the United States, it currently doesn't operate with the same capitalistic structure that should theoretically limit government intervention. Secondly, the Chinese, like their government, are cash rich. In other words, China and its people actually have the means to spend and stimulate their economy. Lastly, while the U.S. government is busy plowing capital into ailing businesses like AIG (NYSE: AIG  ) and Citigroup (NYSE: C  ) that will likely never generate long term economic growth, the Chinese are making meaningful investments.

For example, nearly half of China's stimulus package is earmarked to build infrastructure and another 25% will be allotted to rebuilding parts of the Sichuan Province that was devastated by the earthquake in mid 2008. In comparison, just 5% of President Obama's plan will be invested in infrastructure.

The ultimate competitive advantage
Like many financially sound and vibrant domestic companies facing headwinds from the U.S. recession, China's great potential is being masked by the global downturn. In turn, stock valuations are selling at valuations extremely low in comparison to recent years.

Company

Forward P/E

China Mobile (NYSE: CHL  )

10.5

Baidu (Nasdaq: BIDU  )

24.0

American Oriental Bioengineering (NYSE: AOB  )

4.5

China Green Agriculture (AMEX: CGA  )

3.8

China Medical Technologies (Nasdaq: CMED  )

6.2

*Data from Yahoo! Finance.

However, the recent rally suggests that investors may be warming up to China again. Even Marc Faber – otherwise known as Dr. Doom – has a bullish outlook on China's market.

It is too soon to tell if the rise in China's market will hold in the near term. But with the help of the stimulus package, I believe that China is in the position to use this turbulent time to build a competitive advantage and emerge from this crisis stronger than ever.

More Foolishness about China:

Fool contributor Kristin Graham owns souvenirs from her visit to China but none of the companies mentioned in this article. China Green Agriculture and American Oriental Bioengineering are Global Gains recommendations. American Oriental Bioengineering is a Hidden Gems pick. Baidu is a Rule Breaker selection. The Fool owns shares of American Oriental Bioengineering and has a well-traveled disclosure policy.


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