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Everyone loves to ride a hot trend, but in too many cases, the hysteria is much bigger than deserved.
When it comes to hot trends, it's hard to come up with a hotter one than Chinese stocks. But as I see it, the "invest in China" craze has reached irrational proportions, and it's time to start paring any picks specifically intended to capitalize on the Far East's alleged surge in consumerism.
The rest of the story
It's hard to argue that China hasn't been an investment-worthy spot in recent months. The country's nearly $600 billion in government stimulus occurred almost entirely in the first half of the year, and the Chinese economy has responded quickly. China's annualized gross domestic product growth during the second quarter rolled in at 7.9%, topping previous estimates of 6.1% by a wide margin.
The fiscal strength trickled into stock prices, too. The Shanghai Composite has risen 65% so far this year, handily beating results in the U.S. and most of the rest of the world.
Yet to understand China, you have to look beyond government spending and stock prices to the underlying economy. Take a look at some of the data suggesting China's consumers aren't faring as well as the country's industries:
- The official "urban unemployment" rate of only 4.3% sounds wonderful, but it doesn't consider the 60% of the country's residents employed in the private sector.
- According to one government official, around 3 million recent college graduates in China -- roughly a third of the total -- can't find work, 30 million previously employed workers lost their jobs late last year, and about 2 million migrant workers remain out of work.
- Yes, China's banks are lending, but that's likely because the government is strongly urging them to lend. In the first half of the year, lending was up 28% to more than $1 trillion, but does higher lending make sense with high unemployment? Keep reading ...
- The People's Bank of China recently said nearly 5 billion yuan (about 730 million U.S. dollars) in credit card debt was more than 60 days late for the first half of 2009, an increase of 133% from the year-ago period.
Those are hardly signs of healthy Chinese consumers.
Tightened purse strings
I don't want to imply that tepid consumerism in China is a permanent condition. It's simply a condition that hasn't gotten better yet, and I don't see any real catalyst on the horizon to improve things.
For instance, look at Yum! Brands (NYSE: YUM ) and its recent results. Its China division posted an 8% increase in revenue last quarter thanks to new store openings, but same-store sales in China were actually lower by about 4%. That's not good news, given that China accounts for more than 30% of the company's revenue. Profits and margins have held up well thus far, but it's uncertain whether the company's big investment will keep paying off as an influx of outside investment saturates the consumer market.
Yet companies continue to invest in China. Coca-Cola (NYSE: KO ) has accelerated its Chinese investments with a $2 billion initiative to build new bottling facilities and make Coke products more available. Last year, PepsiCo (NYSE: PEP ) announced a similar $1 billion investment program in the country over four years. Yet if the Chinese won't spring for a little fried chicken, are bottled beverages somehow going to fare better?
The beverage makers aren't alone. Ford's (NYSE: F ) auto sales in China rose by 14% in the first half of 2009. But with Chinese consumers having trouble paying credit cards, can they afford car loans? Similarly, Advanced Micro Devices (NYSE: AMD ) relies on China for more than 40% of its revenue, while companies like Starwood Hotels (NYSE: HOT ) and cosmetics retailer Elizabeth Arden (Nasdaq: RDEN ) both need consumers to step up and spend. It remains to be seen whether the investments these companies have made to expand their presence in China will pay off.
Getting back to work
My point is that for China's consumers to really start spending again, a lot more of them have to find jobs. But that may not happen anytime soon. Although some argue that a global rebound will spur Chinese job growth, I'm not so sure now.
Fed Chairman Ben Bernanke has said the U.S. recession is very likely over, yet unemployment here remains at multiyear highs. Moreover, despite all the green shoots, China's exports were down 23% for August, compared with last year. That doesn't bode well for a Chinese hiring spree, and poses the possibility of a true jobless global recovery.
From the way share prices have jumped, though, it's apparent that investors are counting on China paying off in a big way. That makes U.S. consumer stocks with big China stakes heavy on risk now. With prices already assuming China will keep performing well, shareholders should look out below if actual results fall short of those lofty expectations.