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Yoshikami: Betting Less On China

Wednesday, 26 Oct 2011 | 8:14 PM ET

Views on China have become highly polarized with investment sentiment swinging between boom and bust. As is usually the case, the real truth is a mix of the two but we believe the facts suggest that the decade long explosive growth of the Chinese economy is beginning to moderate. We believe that China is moving towards an inevitable economic slowdown.

Philippe Lopez | AFP | Getty Images

As an institutional money manager we've already begun to reduce our bets on China; here's why.

China’s double-digit growth is a thing of the past. Growth moderated to its slowest pace in more than two years in the third quarter, expanding 9.1 percent compared to 9.5 percent in the previous quarter. China is unlikely to return to its boom years of the last decade, and GDP will probably hover around 8 percent or less, with consumer inflation at around 5 percent, compared with 2 percent in the last 10 years.

Exports of goods and services are a major component of China's GDP. The crisis in Europe and the U.S. will continue to weaken demand for Chinese-made goods. As an illustration of this trend, China's biggest export market Europe, more than halved its imports over the last month.

On the currency front, the overall trend of the appreciation of Chinese yuan is likely to remain intact. The worldwide clamoring for currency action by the Chinese appears to have had an impact on China; the trend is clearly up. Since the beginning of the year, China’s currency has strengthened about 3.5 percent against U.S. dollar. It's a simple formula: as a currency rises, goods from that country will cost more to buy, impacting exports.

Additionally, China’s one-child policy mandated in the 1980s is beginning to have an economic impact. The policy has led to demographic distortions with the country’s population aging rapidly. That age shift is likely to impact growth in two ways: domestic consumption and the labor force.

Spending will be impacted by an aging population - as older consumers tend to spend less. There are reasons why advertisers favor the 25 to 49-year-old consumer demographic; they spend more.

Additionally, a shrinking labor force and China’s economic success has led to a smaller pool of impoverished workers willing to toil in factories under less than ideal conditions. This has led to an increase in wages and eroded China's price advantage in exports.

Real estate prices continue to be impacted by China's attempts to slow inflation. China Vanke , the country’s largest property developer by market share, has reported its second straight month of lower sales in September compared with the previous year. There are now reports of newly built apartments in cities throughout China sitting empty. Yes, China is less leveraged than the West but the risk remains that a speculative real estate market (and a burst of a price bubble) could have a great impact on the health of China's economy.

So How Should You Invest?

I believe the best course of action is to begin reducing exposure to China. Be tactical; conditions demand this perspective.

And for your remaining China assets, you need to become more targeted than ever before. Hold names in China that have sector tailwinds. We like names like Li & Fung , Alibaba Group and China Mobile . These companies have a strong operating history and are in industries that should enjoy future expansion.

Sector focus matters. Look for companies in technology, supply chain management, staples, wireless, education and affordable goods. We are less optimistic on financials, industrial and materials. These sectors will be impacted by a GDP slowdown and a de-leveraging economy.

Avoid speculative names driven by sentiment. These stocks will struggle as investors become more selective and punish companies with high price-to-earnings (PE) ratios. Social media company Renren shows what can happen when investor appetite becomes more selective. The growth stock had a share price of $24 earlier this year and now trades below $7.

And as you reduce your exposure to China, look globally for other opportunities. We believe it's critical to spread investments across the region (and the world) in order to maximize the odds for success. There are other countries in Asia that hold promise: Singapore, Malaysia, Indonesia and Korea. Successful investors will be those that recognize profit can come from many different regions and countries. Even wealthy Chinese have begun to diversify outside of China; follow their lead.

In every economic sense, China is a young nation coming of age, and that comes with significant systemic and structural issues that will likely impact growth for the foreseeable future. Of course, the U.S. and Europe have greater difficulties than China to be sure and China still has plenty going for it. But the time to be selective is now. And the time to proactively adjust your strategy based on a growing headwind for China's GDP is now as well.

Michael A. Yoshikami, Ph.D., CFP®, is CEO, Founder, and Chairman of YCMNET’s Investment Committee at YCMNET Advisors, Inc., a registered investment advisory firm. He oversees all investment and research activities of YCMNET. He is a respected lecturer speaking frequently on market issues, tactical asset allocation, and investment strategy. Michael and YCMNET were ranked as one of the top 100 investment advisors in the United States for 2009 and 2010 by Barrons. He appears regularly on CNBC and CNBC Asia and can be reached directly at m@ycmnet.com

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