An Investment Opportunity With Two Chinas
March 03, 2014

An Investment Opportunity With Two Chinas

Earlier this week, my wife Pele and I crouched beside a small fire, a handful of miles from the Chinese town of Yungshuo. Keeping us company was a school principal and an elementary teacher. The principal added charcoal to the wok-like pit as carbon monoxide rose from the flames.

We weren’t on a winter camping trip.  Instead, we were in a Chinese school’s administrative building, which doubled as a teacher’s staff room.  Pele and I were there as part of a service trip with 20 tenth grade students from Singapore American School.

An Investment Opporutnity with Two Chinas

 For some geographical background, Singapore is closer to Australia than it is to China.  It’s a wealthy city-state, nestled between Malaysia and Indonesia.  While Singapore’s first world amenities resemble those in the Chinese flagship cities of Shanghai and Beijing, there’s something decidedly third world about the rest of the Middle Kingdom.  In the news, and in life, there really are two Chinas.

The school we visited represents the first China.  None of the walls were insulated.  With no school heater, kids shivered in rickety desks, many of which were falling apart.  Walls resembled the scruffiness of a third world prison.  Many of the classroom windows were broken.

 I asked Eban Farnworth, a Yungshuo-based British expatriate, whether we were in one of the poorest schools in China.  “No,” he laughed, “because of this region’s economic strength [there’s a robust tourist industry] it’s far above average.”

To avoid getting poisoned by the indoor coal fed flame, I tried to make myself useful.  During a school break, I wandered into one of the classrooms and tried to fix a few of the desks.  The nails we bought from the nearby town buckled under the hammer.  Sometimes, they snapped in half. 

But there’s a second China—the one Time World reports having more billionaires than any other country, with the exception of the U.S.  In this China, they can’t seem to buy enough Rolls Royce cars. According to the Wall Street Journal, Rolls Royce sells more cars in China than they do in the U.S.  Automotive News reports that more Porsches will soon be sold in China than are sold in the United States.

Yet in the first China, 13 percent of their 1.3 billion people lived on less than $1.25 per day.  The World Bank says China has the planet’s second highest number of citizens living in poverty, trailing only India.  While in Yungshuo, I went for morning jogs along a quiet riverside road.  I ran past makeshift shelters composed of tin slabs, not unlike the squalor I’ve seen in parts of Tijuana, Mexico.  But it was cold.  Propped against rock walls, the residents used cardboard, plastic and whatever else they could scrounge to keep out the chilling wind. 

In the second China, student test results put the rest of the world to shame.  But the first China isn’t allowed to compete.  Schools, like the one I visited, don’t take part in the OECD Program for International Student Assessment exams.  The only schools included in the broad sampling are those in Shanghai and Hong Kong—cities representing less than 2% of the country’s population.  

In contrast, when other countries submit exam results, they’re from a randomly selected national cross-section. If China were to provide countrywide samples, I suspect results would be different.

So which is the real China?  Both are.  And the paradox could be a key for investors. When the world focuses on the second China (the world’s second largest and fastest growing economy) the country’s stock prices soar.  But when focus shifts to the first China (one of poverty, political deceit and shabby schools) stocks languish.  If you have faith in the Chinese economy—and it is growing rapidly—you may want to capitalize when international sentiment sinks.  As the old saying goes, it’s best to invest when there’s blood in the streets.

That could be now.  Chinese stocks are cheap. The iShares MSCI Chinese index (MCHI) has a PE ratio of just 8X earnings, roughly half the cost of U.S. stocks.  I’m not suggesting you load up on Chinese exposure.  Globally diversified portfolios are a far more responsible way to invest.  But if you want to play with a bit of money, keep your eye on China.  When international headlines of Chinese food shortages, rigged student test scores and poverty outnumber stories of young billionaire Ferrari purchases, it might be time to buy.

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