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China stocks are still scary at this level

The long-term outlook for China is positive but the short-term outlook for the equity market is highly uncertain.

After a huge run-up in the last year and a half, the Chinese market has given back a significant percentage of the previously captured gains. But just because there has been a downturn in Chinese equities as of late, we should not be lulled into a false sense of security the Chinese equities have in any way bottomed.

Remember: Chinese investors tend not to buy the value of a company, but instead tend to trade based on the perceived demand for shares. It's a more momentum-based focus for investing and one that can create incredible volatility as we have seen over the course of the last 18 months.



A man watches stock prices at a brokerage in Beijing, China.
Getty Images
A man watches stock prices at a brokerage in Beijing, China.

I recently moderated a panel in Silicon Valley held by a Chinese city seeking foreign investors to their business development zone. It included technology venture capitalists, a medical-device CEO, the head of a major U.S. financial institution and a representative from the Chinese government.

One of the takeaways was that the Chinese economy is, indeed, undergoing a significant transition towards a more balanced economy. The new Chinese leadership is focused not just on growth but structure and regulation as well; this is an important distinction compared to previous leadership.

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When China was moving along at a 10-percent growth rate, it was an economic land-grab. The focus was on remaking China's economy to be one more focused on global pursuits and increase of Chinese influence on the global economy. Regulation and difficult infrastructure issues were not the main focus of business leaders and governmental agencies. The new perspective and the Chinese government is one focused on growth in a measured way. Corruption is being attacked and accountability standards are now becoming part of the government's operational DNA. Unbridled growth goals have given way to measured progress.

Fewer 'ghost cities'

A more sober perspective by the Chinese government and business leaders is now focusing on core infrastructure issues rather than building more ghost cities. It's a well-known fact within China that most major cities have inadequate transportation and underground infrastructure. When it rains in China, cities flood and the government is beginning to focus on this issue as a way to spur GDP growth through new construction projects, while at the same time handling waste-disposal challenges that existed in Chinese cities for decades. Consider this a form of the United States government-works projects started in the Great Depression and recently replicated by the Obama administration during the height of the financial crisis.

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This type of project is not glamorous and usually gets little press but it does show that China isn't simply whistling in the dark as the economy continues to struggle. There is a plan in place, according to business leaders I spoke with, that is clearly designed to set the stage for China's next burst of economic growth.

The next burst of growth: wireless

A comment was made consistently throughout the evening the China is a leader in certain areas and lags far behind in others. For example, the wireless infrastructure and connectivity of the Chinese is in many ways superior to that in the United States. Companies are springing up around China, particularly in Shenzhen, designed to cater to the Chinese preference to live a connected life. One only needs to explore the myriad of applications and services available within the WeChat application to recognize that Chinese entrepreneurs are focused on capturing the growing opportunity in the wireless space.

On the other hand, the distribution of goods and services through brick-and-mortar stores trails other countries in a significant way. What consumers take for granted in the United States is that there are locations providing a wide variety of choices where consumers can make judgments between products based on quality and pricing. The lack of a more robust brick-and-mortar presence for stores within the Chinese landscape is an indication of the challenges companies have in providing products to consumers in a traditional retail environment. This problem is not improving and, in fact, there is evidence to suggest that retail is increasingly becoming an online exercise for the Chinese consumer with many brick-and-mortar offerings drying up on a local basis.

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I remain convinced that China will turn the corner. This week's discussions confirmed our views for the long-term. But this week's discussions also confirmed to me the China equity markets are not for the meek. It is entirely possible that China's equity markets could fall further and would need to if one was to buy based on value.

Commentary by Michael A. Yoshikami, the CEO and founder of Destination Wealth Management in Walnut Creek, California.