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An ETF To Suit China's Economy

Investors would be better off going with the Claymore/AlphaShares China Small Cap than the iShares FTSE/Xinhua China 25 Index.
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) -- The Chinese government warned Thursday that a reduction in global stimulus policies beyond its control could affect China's asset prices in a volatile manner.

That warning followed other interesting reports earlier this week on China's January economic performance and the government's plans going forward.

All of this information raises some concerns about China's economy and whether investors should use China-focused ETFs at this time, such as the most popularly traded one,

iShares FTSE/Xinhua China 25 Index

(FXI) - Get Free Report


The January report grabbing the most headlines this week was the increase in Chinese exports by 21% and imports by 86% from a year earlier. The large increase in imports is reflective of a more active domestic consumption that is linked to government stimulus measures and increasing personal incomes.

The dual influence of wealthier individuals and stimulus from the government also helped create another headline grabbing figure for January. Auto sales in the country increased 116% in January compared to sales a year ago.

However, China's outlook may not be as rosy as these numbers would suggest. For instance, in the case of the auto sales, the impressive number is large because it is being compared to a dismal figure from January of 2009. Last January was in the middle of the recession, as opposed to this year when the economy is recovering and the government has kept stimulus measures in place for auto purchases.

Also, this January benefited from the run-up in shopping that takes place before Chinese New Year, while the year-ago sales were lower due to the Lunar New Year holiday falling in January.

Looking at copper imports for January also shows there could be reason to not get overly bullish on China just yet. Copper imports for January were up 28% for the month compared to a year ago, but down 21% in comparison to the level in December and were less than expected. Aluminum imports were also down from the previous month.

On the topic of expectations, interestingly, the headline-grabbing exports number for January was also less than what analysts had estimated while the yuan forwards declined on the news on the decreasing odds that the government will let the currency appreciate.

The Chinese stock markets ended higher on Wednesday, though, on what was perceived to be strong export data and on comments from the Bank of China's governor that made investors less concerned about inflation.

The CPI numbers for January out that came out today were lower than expected and lessen fears about inflation, but the PPI for the month was higher than expected, meaning inflation still is a concern.

Also, the government is going to have to find a way to deal with the fallout from lending limits put in place. It was reported today that new loans for January were greater than the previous three months combined. Reduced lending in the coming months may lead to a downturn in property prices, which increased by 9.5% in 70 cities in January from a year earlier.

Inflation will be even more of a concern if the government decides to raise minimum wages as an alternative to buckling to U.S. pressure to appreciate the yuan. The government also thinks higher wages would stimulate their domestic economy more so than currency appreciation and help wean the country off export dependency. This move would be ultimately good for Chinese workers, although there may be less employment and exports could take a hit as the minimum wage would cut into already slim margins for exporters.

This is a critical time for China. In the mid to long-term, it wants to move away from an export oriented economy and time will only tell if the country is ready for this -- and if the government can handle the delicate transition appropriately.

I am confident that it can ultimately achieve this, so China ETFs look sound as a small international component to a diversified long-term portfolio. It would behoove even long-term investors to try and buy at any low dips going forward though, which I suspect still could occur.

Also, as opposed to the popular FXI, I would recommend that investors choose

Claymore/AlphaShares China Small Cap

(HAO) - Get Free Report

. That's because out of the China funds, its companies would benefit most from domestic consumption, the expansion of which is a top priority for the government. HAO's chart also looks less bearish than FXI's currently.

In the near term, the government has an asset bubble concern that may prevent it from extending stimulus measures and we saw last month how cranky the markets got when credit tightening and stimulus reduction was a looming issue.

Also, now coming into play thanks to Greece, will be a potentially extended depression in the value of the euro, which, although China has done a good job spurring domestic and regional demand, will hurt exports and the bottom line of its economy this quarter.

-- Written by Don Dion in Williamstown, Mass.

At the time of publication, Dion did not have any positions in the funds mentioned.

Don Dion is president and founder of

Dion Money Management

, a fee-based investment advisory firm to affluent individuals, families and nonprofit organizations, where he is responsible for setting investment policy, creating custom portfolios and overseeing the performance of client accounts. Founded in 1996 and based in Williamstown, Mass., Dion Money Management manages assets for clients in 49 states and 11 countries. Dion is a licensed attorney in Massachusetts and Maine and has more than 25 years' experience working in the financial markets, having founded and run two publicly traded companies before establishing Dion Money Management.

Dion also is publisher of the Fidelity Independent Adviser family of newsletters, which provides to a broad range of investors his commentary on the financial markets, with a specific emphasis on mutual funds and exchange-traded funds. With more than 100,000 subscribers in the U.S. and 29 other countries, Fidelity Independent Adviser publishes six monthly newsletters and three weekly newsletters. Its flagship publication, Fidelity Independent Adviser, has been published monthly for 11 years and reaches 40,000 subscribers.