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Many see China as the next great economic superpower. Yet China could be facing a big problem: It appears to be going down the same dangerous path the U.S. paved earlier this decade.
Repeating the mistakes of others?
As the U.S. came out of the 2001 recession, policymakers kept interest rates low for a long time to ensure that the economic recovery was sustainable. However, many now believe that low rates planted the seeds of the housing bubble, which in turn created the financial crisis we've struggled with for more than a year.
Similarly, this time around, China has instituted low interest rates and lax lending policies in an effort to ward off recession and return to torrid economic growth. That has already led to concerns of what The Wall Street Journal called a "speculative frenzy" in Chinese assets. Already-expensive Chinese real estate has continued to rise at a rapid rate, and the Shanghai composite index has surged by more than 50% this year, outpacing the S&P 500. Internet titan Baidu (Nasdaq: BIDU ) has tripled so far this year, while other Chinese companies, such as insurer China Life (NYSE: LFC ) and oil giant PetroChina (NYSE: PTR ) , have also posted strong gains.
So is China for real?
Given the speed at which both real estate prices and the stock market have surged, this raises the obvious question: Is China's growth sustainable, or is an asset bubble brewing?
Some have big concerns. "People don't focus enough on the price of housing in Shanghai," said Simon Johnson, the former chief economist of the International Monetary Fund who is now a professor at MIT's Sloan School of Management and a senior fellow at the Peterson Institute for International Economics. "Seriously, I think the next wave of bubbles is coming in emerging markets and is probably coming in Asia."
That said, Johnson says Asia does have a good fundamental story. "China's economic power is very real, though that's not inconsistent with my view that the next big bubble is coming in Asia." Johnson says every bubble starts with a truly convincing shift in fundamentals.
Uri Landesman, head of global growth at ING (NYSE: ING ) Investment Management, told me he thinks China's growth story will continue. "But I think people have to realize that they did a tremendous amount of raw-materials ordering in general industrial production in the first half of the year and it may take some time for consumption either domestically, or from their export partners, to soak up all that production," Landesman said.
Although China's economic growth could slow down somewhat in the short term, as the country digests its heavy stimulus spending and production ramp-up, Landesman says long-term economic growth should continue humming.
Bob Doll, vice chairman and chief investment officer of BlackRock (NYSE: BLK ) , agrees. "Economically, China is doing OK," Doll says. "I don't think there's any catastrophe in China. I think it's struggling as all emerging markets do to get on a firmer footing."
Doll says that China was the first decent-sized market to recover, and the fundamentals in China are much less skewed than its stock market would portend.
Still, even sound fundamentals won't make Chinese stocks immune to a future crisis. As Simon Johnson points out, "I'm not saying that the next crisis is going to happen in six months, or two years, or even three years. Emerging markets often get into a five- to 10-year cycle. I'm just saying that the way our financial markets operate, we tend to get carried away with these speculative frenzies. The Internet bubble was based on a reality. We have the Internet, and it really has changed everything, but we got carried away."
What should you do now?
Right now, China is leading the global recovery and is in the midst of a long-term industrialization period. That's something investors should look to get a piece of ... albeit cautiously. Investors should recognize that these stories, which assume torrid growth and rising asset prices, can lead to quick run-ups in valuation. So as I said, tread cautiously.
One idea worth considering is China's largest producer of offshore crude oil and natural gas, CNOOC (NYSE: CEO ) , a Motley Fool Global Gains recommendation. China's economy has begun to recover through stimulus aimed at infrastructure projects, which require oil and gas to power projects. The stock is already up 47% this year, but if energy prices continue to climb and China's economy remains buoyant, CNOOC could churn out strong earnings for years to come.
Investors should definitely keep including China among their strategic plans. As prices rise, though, you should remain cautious about the prices you're willing to pay.
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