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Who's Afraid of China?

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If your stocks have limited China exposure, then don't expect outperformance in 2013. Exposure might be buried in revenues or equity risk taken directly, but it MUST be there. That is because China is a market elephant now; you can't avoid it.

The internal migration reshaping the country? - Epic
Its demand growth? - Picking up
Investment signals? - Positive!

All of this provides a strong catalyst to take shares higher. So in the next few paragraphs, I am going to show you what is going on with China and how to invest more successfully in 2013 because of this key trend.

What is Going on With China's Economy?

China's consensus GDP forecast is rising.

Growth is forecast at +8.1% for 2013 after +7.7% in 2012. We heard much about China's slowdown, but not much about its current recovery. Truth is, over 40% of ALL the world's economic growth comes from China -- no small matter for investors.

Inside China's financial markets, I see upside -- China's retail sales are up +14% year over year. With low forward P/E ratios, Chinese stocks look reasonable even after the recent eight-month long rebound. China's managed currency may be a political hot potato, but it lowers currency risk for investors.

China's CYCLICAL slowdown signaled its end in June 2012.

The 2012 slowdown was a back-end signature of their huge 2009 fiscal stimulus. Late in 2010, tight money began to attack a housing price bubble. Two years later, slower growth cooled prices, and put in place a stable expansion.

In June 2012, the People's Bank of China [PBC] cut its average 6.5% rate to 6.0%. It can go to 5.3% to match the 2010 low. To skeptics who see slack, I ask this: Why doesn't the PBC go to 5.3%?

After ending speculation, housing bottomed. Prices have come down -10% to -15%. Wage growth of +10% to +20% a year means home affordability is up +30% to +50%. Now, home and auto sales - accounting for 40% of China's consumer spending - should pick up.

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How does a bull respond to criticism that China is just a pumped-up Communist State focused on cash flow rather than equity returns?

The answer: There is an epic move underway. The Chinese economy is around 50% rural, while the U.S. is under 2% rural now. In 2000, China was around 35% rural. This internal migration is in its middle stages, with citizens moving from small farms to work in factories, while living in apartments in cities. High growth reflects supply and demand - in terms nearing 200M migrating peasants.

Net urban-rural migration in China? - a whopping 21 million for 2015.

Break this into Hokou (migrants with local residency rights) and non-Hokou (migrants without local residency rights) or the "floating population". In manufacturing and construction, non-Hokou workers make up 43% and 56%, respectively.

How This Affects the World Economy? The global growth bright spot in 2013 - China.

Outside Asia, growth looks flat. The world's GDP growth forecast is +3.2% for 2013, compared to +3.3% for 2012. Strong China growth and weak growth in advanced countries is not unrelated. China may be the only major economy right now where monetary policy works the way it is supposed to. In Japan, Europe and the U.S., the tail of weak GDP growth wags the dog of monetary policy.

Zero rates in advanced countries point another finger towards investing in China.

This is an unintended, but not an unforeseen, consequence. Fed and ECB policy tries to raise domestic growth via interest rate pre-commitment and bond buying. However, look for higher P/E multiples on all stocks, including Chinese stocks. The reason? Low rates push investors into risk.

Faster Asian development means capital flow and currency appreciation pick up.

In Asia, countries compete for exports to slow-growth advanced economies. Currencies like the Singapore Dollar and South Korean Won rose +7% in 2012. Appreciation is the likely trend in 2013 for the entire region, except Japan and Australia. Another benefit for the right stock investors!

Now, What is the Investment Strategy?

You have to position yourself for growth in the Chinese economy.

By 2013, there will be 1.36 billion people in a China with $18 trillion in GDP, at constant prices. By 2015, GDP gets to $21 trillion. In two years, $3 trillion in new spending materializes - 20% of the current U.S. economy.

A major policy catalyst in 2013 - new Chinese leadership comes into power.

A value investor has a play. China is five years out from a major sell-off on the Shanghai Composite. Share prices went from over 6,000 to 2,100. They are now around 2,300. Below, I see upside continuing for the FXI iShares China 25 Index.

FXI China 25 Index Fund (blue) vs. S&P 500 Equal Weight (green)

FXI China 25 Index Fund (blue) vs. Industrial Inputs Price Index (red)

How to Play this Trend?

Chinese or non-Chinese picks can track China GDP growth and confidence.

When China grows +8% a year, and purchasing parity adjusted incomes are $12K, out emerges +$1000 in fresh income to capture each year. You don't have to buy Chinese stocks to tap into that opportunity. From consumer discretionary stocks to auto makers, industrials, old school materials; there is no shortage of U.S. based companies that stand to benefit from this trend.

What To Do Next?

First, look for the companies experiencing better-than-expected growth. Considering the trends in place, that growth will likely be tied to what is going on in China. The good news is that our proven Zacks Rank stock-rating system will isolate these companies and our experts will zero in on the top recommendations.

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John Blank

As Chief Equity Strategist, John Blank, PhD, publishes weekly articles and monthly periodicals on the global financial markets for Zacks Premium subscribers and He also appears on television channels such as CNBC and on a weekly Chicago radio talk show, Investing in Today's Markets, to discuss Zacks Macro, Zacks Market Strategy, and Zacks Consensus Strategy reports.

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