Sunday, October 4th, 2015

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Investors Should Be Wary of China

Investing in China has been less profitable than many would expect.Many look at the still-struggling U.S. economy and Europe slogging through a growing sovereign debt crisis and see great appeal in the fantastic growth of the Chinese market. But MarketWatch's Sam Subramanian suggests that the economic growth in China hides what really amounts to a poor investment.

Though Chinese GDP growth dropped sharply in 2008, it fell only slightly more than 30 percent, compared to more than 115 percent in the U.S. Since then it has maintained relatively steady growth ranging between 9.2 percent and 10.3 percent while the U.S., Europe and much of the rest of the world have struggled.

Yet in that time, the MSCI China index has fallen a shocking 45.3 percent from the rough beginning of the financial crisis in October 2007, while S&P 500 now sits at 11.6 percent below that point. Even Europe has performed better, with the MSCI Europe index at 40 percent below October 2007.

Subramanian cites three primary reasons, beginning first and foremost with valuation, but also including problems of corporate governance in China and the growing threat of inflation in China.

When the financial crisis struck, China still seemed like the next big investment, with numerous Chinese companies making their initial public offerings in the west. However, these companies gave themselves remarkably high valuations that investors were only willing to pay because of the incredible promise of the Chinese market.

However, many Chinese companies have structured themselves to essentially beat the market in the long-term, with strong government support allowing them to expand production capacity and invest heavily without as much concern about immediate profitability. With less concern about pleasing investors, these companies were happy to take the long view against their competitors.

Only adding to this problem, these companies are heavily reliant on exports because, while the recession has not slowed Chinese growth, it has hampered domestic spending. Before 2008, China was seeing significant increases in domestic spending as well as exports, but increasing inflation in the country has made this difficult. The government has attempted to restrict inflation by limiting loans and enforcing more stringent reserves requirements, but this only serves to reduce business investment.

Nevertheless, Bloomberg reports that the Chinese Ministry of Commerce saw investment in the country rise 8.8 percent in October from the year before, reaching as high as $8.33 billion.

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