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Keeping an Eye on the Chinese Economic Engine

Tuesday, July 6th, 2010
By for Profit Confidential

“Calling the Trend” Column, by George Leong, B. Comm.

The benchmark Shanghai Composite Index (SCI) continues to hover around 3,000, but is down about eight percent this year. The recent correction was driven by concerns of a real estate and credit bubble forming in China and the decision of the Chinese government to halt lending by banks. The action is feared to hurt economic growth in China, but, at the same time, it may be the right move to avoid a financial collapse in the country. I feel that the fact the SCI is holding at 3,000 reflects the support for the move.

China is continuing to grow well beyond the growth rates in North America and Europe. Yet with the growth comes inflation. The Chinese government knows this and is staging its own battle to combat uncontrollable growth.

China wants to see its economic engine surge forward, but at the same time we must understand that, without control, it can become sort of like a runaway train. Government officials may force the People’s Bank of China to increase interest rates there in order to curb the growth.

The country is targeting GDP growth of eight percent for this year, which is below some estimates that peg GDP growth at over nine percent. The key is to maintain growth without causing problems with inflation and surging property values. “Improving people’s well-being is the fundamental goal of economic development,” said Wen Jiabao in a report to the National People’s Congress.

The country’s manufacturing sector remains strong and will continue to drive China’s economy forward over the next decade. China’s Purchasing Managers’ Index (PMI) came in at a seasonally-adjusted 52.0 in February, below the estimate and the reading in January, but continuing to point to expansion.

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The problem in China remains the threat of an asset bubble, but it is only a threat. The International Monetary Fund recently suggested that there is no serious risk of asset bubbles and that China could see GDP growth of 10% in 2010, according to The Wall Street Journal.

China does not want to risk major impact to its growth and would rather slow it down a bit to avoid a potential meltdown. But with consumer prices surging 2.7% in February from a 1.5% increase in January, there is a fear of inflation and uncontrollable growth. On the producer side, the producer price index increased 5.4% in February from 4.3% in January. The readings are somewhat high, but the CPI is still within the target of three percent set by the Chinese government. We could see higher interest rates if inflation continues to grow. The People’s Bank of China said that it would “…gradually guide monetary conditions back to normal levels from the counter-crisis mode” in its quarterly monetary policy report, according to Bloomberg.

And, unlike in the United States, property prices are surging in China, up 10.7% year-over-year in February, according to the National Bureau of Statistics. On a positive note, to avoid a housing bubble, the sales volume of residential properties fell to 37% in January and February, down from the 50% growth rates at the end of 2009.

The bottom line is that playing the Chinese capital markets involves excessive political and economic risk. Yet, as I have said, you need to be well-diversified, so this would enable you to play some Chinese growth stocks, especially those of the small-cap variety.

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George Leong - Financial Planner, ConsultantGeorge Leong, B. Comm. is a Senior Editor at Lombardi Financial, and has been involved in analyzing the stock markets for two decades where he employs both fundamental and technical analysis. His overall market timing and trading knowledge is extensive in the areas of small-cap research and option trading. George is the editor of several of Lombardi’s popular financial newsletters, including The China Letter, Special Situations, and Obscene Profits, among others. He has written technical and fundamental columns for numerous stock market news web sites, and he is the author of Quick Wealth Options Strategy and Mastering 7 Proven Options Strategies. Prior to starting with Lombardi Financial, George was employed as a financial analyst with Globe Information Services. Add George Leong to your Google+ circles