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This is a special week for CAPS' Weekly Top Stock Idea -- it's our first short pick.
iShares FTSE/Xinhua China 25 Index
|Stock Price at Short Recommendation||$42.69|
|Market Cap||$7.9 billion|
|Top 10 Holdings||China Construction Bank|
Industrial & Commercial Bank of China
China Life Insurance
China Petroleum & Chemical
Bank of China
Sources: Capital IQ (a division of Standard & Poor's), Yahoo! Finance, and Motley Fool CAPS.
This Week's Pitch:
China is in a bubble right now, driven primarily by the Chinese government. The major contributors to this bubble have been the Dollar peg in China, coupled with regulatory limitations on investments inside the PRC. Add a massive stimulus package back in '08 to these already distortive measures, and you get a giant real estate and commodities bubble.
Just how ridiculous has it gotten? About 70% of the China's GDP is dependent upon construction and fixed asset investment. Compare that to about 15% construction/fixed asset investment in the U.S. during the peak of the housing bubble. There are entire "ghost cities" in China, and in the larger cities like Shanghai and Beijing, it's not uncommon for completely empty buildings to exist, with the units costing about 30 times the yearly income of the average middle income worker in China.
Once this bubble crashes, perception about the risks of emerging markets is going to shift again. Right now, people are convincing themselves that the U.S. is less safe than emerging markets, which is based more on national mood and political sensationalism than logical analysis. The U.S. has its issues and risks, but it's vastly safer to invest in stable markets like here than it is in many emerging markets, with controlled markets, lesser legal protections, and limited political freedoms. These markets can provide high-upside opportunities, particularly when they begin to liberalize and reap the benefits of trade, but centrally managed economies are very rarely all that efficient and create much larger bubbles than we see even here in the U.S.
People often tout China's authoritarian regime as an advantage, since it can react much more quickly than the chaotic U.S. government; but I think we're going to see just how wrong that philosophy is over the next few years. China might have an advantage on some infrastructure projects like high-speed rail, but that's not because the Chinese system is spectacular, so much as people don't realize how screwed up the U.S. transportation system. The U.S. transportation system is not a "free market" and is heavily subsidized, politicized, and distorted. China's system on this happens to be better, but that's not enough to save them.
Where the U.S. had an advantage over China is allowing its markets to operate freely more often than not. China's state-imposed controls create massive distortions that are bound to collapse eventually.
FXI is composed of 25 securities traded on Hong Kong and about 49% of it is concentrated in financials. Downside could easily be 40%-70% during a real estate collapse.
The Motley Fool is investors writing for investors. Dan Dzombak did not have a position in any of the companies mentioned in this article. Pitches must be compelling, made in the past 30 days, and be at least 400 words.
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