Waiting Out China's Next Growth Spurt
Rachel Koning Beals

It may be time for investors to hold rather than add, unless they're brave

The compromised buying power of Europe and the United States will have a lot of pull on China's 2012 economic and stock-market fate. There's little Chinese officials can do about that.

But domestically, officials appear to have orchestrated a soft landing after the heyday property and financial boom. Monetary policy changes in China (and for much of the inflation-fighting global emerging market sector) seem to take hold quicker these days and with more punch, at least compared to the slow grind toward recovery in the United States and a period of interest-rate catch-up in Europe.

That could bring encouraging stability to U.S. investors who gain exposure to China through the popular iShares FTSE China 25 ETF (FXI), especially patient investors. The fund is up nearly 11 percent so far in 2012, taking back more than half of the 19 percent loss logged last year.

Still, it may be tough sledding for the fund because its growth engines have been purposefully checked by tighter -- and now steady -- interest rate policy; companies in China's financial, energy, and basic-materials sectors have a 79 percent weighting in the fund.

"For Chinese and emerging market ETFs, it may well be time to hold rather than add, unless you're pretty brave. But certainly, the 12 to 18 months [global economic] outlook is better than it looked six months or a year ago," says Brian Gendreau, market strategist with Cetera Financial Group. "Don't pack up the truck yet."

Slowdown doesn't have to mean letdown. So far, monetary policy is working in China. If officials have managed to brake the property and real estate markets without a skid, chances seem probable that they can ramp it up again. Remember, unlike in much of the developed world, policy has traction in China these days.

China's growth rate slowed to 8.9 percent in the fourth quarter, its slowest pace in two years. The United States grew about 2 percent in the same period. China contributed 9.3 percent of world economic output last year, according to the World Bank.

China tightened monetary conditions and raised bank reserve requirements early in 2011, but late in the year, it eased the reserve requirements for banks, a move meant to loosen lending. Analysts at Barclays have said in recent commentaries that they expect policy easing deeper into 2012.

But first, a rough patch: Economists widely expect additional economic slowing in China. Early year could well be the trough, followed by a late-year rebound. "We expect things to get worse before they get better," Qu Hongbin, China economist with HSBC, wrote in a note to clients.

Risks, always risks. Of course, China's property and housing sectors are fickle. Some forecasts have pegged a 10 percent to 20 percent slowdown in average home prices in 2012. Bank-loan health is vulnerable as a result. Banks lent heavily to property developers and to local governments, many of which used land as collateral.

A similar picture is unfolding for Chinese manufacturing. HSBC released the initial results from its January Purchasing Managers' Index survey of Chinese manufacturers mid-month. It showed activity contracting, though at a slightly slower pace than in December.

And of course, two of its biggest export customers, the United States and Europe, could be forced into frugality for at least a while longer. The world may have come to rely on China stimulating growth in its trading partners, but steady-as-she-goes may be the new normal, for now.

Chinese press, widely quoted in the Western financial press, said China does not have sufficient reason to cut interest rates as the one-year deposit rate was 3.50 percent, still below the 4.1 percent rate of consumer inflation.

It may prove politically important for the People's Bank of China to keep its benchmark interest rate on hold in 2012 and into 2013, a signal of stability in a year with a scheduled leadership change at the central bank.

Some analysts think stimulus could come a bit sooner, perhaps encouraged by policy effectiveness so far.

"As growth has slowed, inflation pressures have eased and copper and commodity prices have declined. We believe this allows room for Chinese authorities to implement domestic stimulus in 2012," says Paul Christopher, Wells Fargo Advisor's chief international investment strategist.