China Still Looks Like the Best Global Bet

Chinese investors likely rue the day they decided to spark a domestic investing frenzy. In November 2006, the Dow Jones Shanghai Index (DJSI) was around 180, and it rose a stunning 250% over the next 14 months. But since peaking this past January, the index has given back all those gains. Although valuations moved far into bubble territory and are unlikely to revisit those highs any time soon, the market does appear to be focusing on all of the Chinese economic headwinds and is giving zero credit to the still-considerable strengths.

The government's recent announcement of more than half a trillion dollars in stimulus, coupled with a host of other investor-friendly moves, has caught attention: the DJSI, after bottoming earlier this month at around 170, has moved up past the 200 mark -- an impressive move in the context of further weakness in most other major equity markets.

To be sure, the Chinese economy has grown so large that the current stalling out will be hard to immediately reverse. A review of recent economic stats gives pause:

• Industrial production grew at an 8.2% rate, the lowest monthly reading since 2001. Sharply negative growth in steel production was the biggest drag.
• Economists now expect GDP to grow round 6% in the fourth quarter of 2008 and the first two quarters of 2009. That's a fast drop from the double-digit gains posted in each of the last seven quarters.
• Sales of cars and trucks fell in the third quarter from year-ago levels. They had been rising at a year-over-year clip of 20% to 30% since late 2005.
• Hundreds of factories in the Yangtze River Delta and Pearl River Delta -- the two strongest manufacturing zones -- have been shuttered in the last few quarters.

Investors can expect to see a steady drumbeat of bad news over the next few quarters as well. But all of the current government actions could start to bear fruit by the second half of next year, even if the country's major trading partners remain in a deep funk. And since investors tend to look out six to nine months, they could turn more bullish on the Chinese market before the economy shows real signs of life.

So here is a quick look at how the Chinese economy may fare over the next 24 months.

You can think of China's economy's rebound as being led in stages by four distinct groups: local governments, the national government, corporations and consumers. Each will do its part, in that order.

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David Sterman has been an equity analyst and financial journalist for 15 years, most recently serving as Director of Research at Jesup & Lamont Securities.