Why We Shouldn’t Underestimate the Power of China

Featuring Lutts’ Logic:

The Tour de France

Kazakhstan and China

A Solid Chinese Investment

I start today with a brief nod to the Tour de France, the annual bicycle race around (sort of) France.  Most Americans don’t care about the race, and I respect that; it’s one reason I won’t spend much time on it.  Nevertheless, I’m a big fan, so I can’t resist making a few observations.

The race this year covers 3,500 kilometers (2,175 miles) over 23 days, with two rest days.  That’s an average of 104 miles per day, at speed, a feat achievable by only the best-conditioned athletes.

Drugs have been a problem in recent years, but strict testing seems to have reduced use dramatically, if not eliminated it.  One hundred and eighty cyclists started this year; that’s 20 teams, with nine riders each.  After nine days, nine riders have dropped out … three with broken bones.  

No Frenchman has won the race since 1985.  American Lance Armstrong, now 37 years old, has won the race seven times, and is still a contender, currently in third place.  

More important, Lance belongs to the strongest team, Team Astana, and a strong team is an absolute necessity if a rider wants to win the Tour.
Finally–and most oddly–Team Astana takes its name from its main sponsor, the capital city of Kazakhstan, which has a booming economy thanks to strong flows of oil and gas money, and the fact that it didn’t participate in the global explosion and implosion of deficit financing.

I read a pleasant little travel/history book last year titled “Apples are from Kazakhstan,” and I recommend it to anyone interested in learning more about the country.  But the book didn’t make we want to visit Astana just yet.  Since Kazakhstan gained independence from Russia in 1991, the city has undergone enormous changes: the name was changed from Tselinograd to Aqmola to Astana; the city was designated the new capital of the country, taking the crown from Almaty; massive government building projects have changed the face of the city; and the population has mushroomed, from fewer than 300,000 in 1997 to more than 700,000 today.

The book did, however, open my eyes to the undeveloped potential of the country, and as this potential is realized, I suspect you’ll be hearing more about Astana and Kazakhstan.

Today’s big idea is about Kazakhstan’s neighbor, China, a country that, as we all know, is changing fast … but is still misunderstood.

While writing the title of this column, I was tempted to use the word xenophobia, meaning fear or contempt of strangers or foreign peoples.  But the word I want (which appears not to exist) means, “underestimating the power of the people of a foreign country.”

Because when it comes to China, I fear that’s exactly the mistake most Americans are making today.
To the vast majority of Americans, China is, first and foremost, a Communist country.  Communists, as we all know, lost the Cold War.  Americans “know” Communism is the wrong way to go.

Communism dictates from the center, while Democracy is rule of the people.  Communism hides the truth, while Democracy confronts the truth.  Communism restrains, while Democracy frees.

Furthermore, as we’ve repeatedly been told, the Chinese are woefully behind the U.S. on matters of human rights.  

During the pre-Olympics construction boom in Beijing last year, we were informed that the government was exploiting workers, by making them work overtime and making them sleep in crowded rooms.

When the Games opened, we were told that the authorities had rounded up all the “undesirables” and either locked them up or shipped them out of the city for the duration … all to make the city presentable for the world.

More recently, the riots between the majority Han Chinese and the minority Uighurs–like the troubles in Nepal months before–have been presented–and received–as just one more sign that China is still woefully behind the U.S.

But in their rush to condemn China for its politics and human rights, I fear Americans make the mistake of underestimating the economic power of the country.


For the past quarter-century, the Chinese economy has grown at an average annual rate of 10%.  This year, it’s expected to grow at an 8% rate … slowing only because Western credit-financed buyers have slowed their consumption.

Those Olympic venues were completed on time and on budget, and you can’t say that for many recent Western-managed Olympic games.  (Nor can you say it for Boston’s infamous Big Dig, the most expensive highway project in the U.S., thanks in no small part to corrupt elected politicians.)

And just last week, we learned that China had surpassed the United States as the world’s biggest auto market in the first half of 2009.  Chinese bought 6.1 million vehicles, while Americans bought only 4.8 million.

Ford Motor sales in China were up 14%, while General Motors sales were up 38%.  But thanks to the financial collapse in the U.S., General Motors went bankrupt.  And now look who owns what’s left of the company!

The U.S. Federal government owns 60.8%.  A union-controlled health care trust fund owns 17.5%.  The Canadian and Ontario governments own 11.7%.  And bondholders of the old GM own about 10%.

I don’t know what to call this unholy marriage, but it isn’t capitalism.  And it’s not Democracy.  No one asked me if they could use my money to buy a failing automaker.

By the same token, what’s been going on in China can no longer be called Communism.

You might call it Commu-Capitalism, but I really don’t care what you call it.  The point is that China continues to grow, and fast.  Its citizens, who were dirt poor three decades ago, are fast becoming members of the global middle class, producing and consuming and enjoying standards of living that were unimaginable for them not long ago.

China & Emerging MarketsQuality health care is growing increasingly available and affordable.

Education is a booming market.

Infrastructure is improving at fantastic rates.

The energy grid is spreading across the country.

Meanwhile, the U.S. struggles to return to positive growth mode, as we pay off the debts from the big cars and big houses we bought in recent decades.

What happens next is unwritten. Anything is possible.  China could stumble.  The U.S. could rally.  Other nations are likely to play crucial roles.  But what’s most likely is that China continues to flourish as it pursues its current policies to expand prosperity and the U.S. continues to struggle, in part because too many Americans are poorly educated, dependent on the government and unwilling to work hard.

Add to that our crushing debt burden and the looming entitlements of Medicare, Medicaid and Social Security and I conclude that as the years pass, it’s unlikely that we’ll be able to fend off China’s rise.

Soon enough, we won’t be #1.

But there is a chance.

If we can, as a nation, wake up and recognize the economic challenge posed by China, we can get to work.  There’s nothing like the perception of a common enemy to unite a population in common cause.  Back in 1957, the Soviet Union’s launch of Sputnik sparked united interest in scientific research that led to the creation of DARPA and NASA and brought numerous trickle-down benefits to America.  A national focus on developing alternative energy sources might pay similar dividends today.

In the meantime, investing in Chinese stocks is a good idea.

Five years ago, I noticed a handful of Chinese stocks performing well and I launched Cabot China & Emerging Markets Report to help subscribers make money by investing in China and emerging growth countries.  

At the time, there weren’t a lot of Chinese stocks to buy.  But I reasoned that the growth wave would continue, and so far it’s worked out pretty well.  In fact, for the five years ended May 31, 2009, Cabot China & Emerging Markets Report was the top performer of all investment newsletters, with a return of 22.2%.

Some of the credit for that goes to editor Paul Goodwin, who followed the tried-and-true Cabot growth-stock methodology in making his buy and sell recommendations.

But a lot of the credit goes to the Chinese economy.  It was booming, it is booming, and in my opinion, it will continue to boom.

Two years ago, I visited China, in part to see my daughter, who was spending a semester at the Beijing School of Foreign Studies, and in part to get a better understanding of the people of the country.  (You can read my Cabot Wealth Advisories from that period in our archives).  When it was over, I condensed my opinion of the Chinese people down to one adjective:  Industrious.

Everything I’ve witnessed since then has only reinforced that opinion.

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One of my favorite Chinese stocks in recent years has been Ctrip.com (CTRP), which you might call the Chinese equivalent of Expedia, the online travel service.

Increasing numbers of Chinese can now afford to travel throughout their own country, for both business and pleasure.  And increasing numbers of them are logging on to Ctrip to book their plane flights, reserve their hotels rooms and rent their cars … or simply to sign up for package tours.

It’s not rocket science; in fact Ctrip just has to watch what Expedia and the other leaders in the industry are doing, and do the same on their own Web site.

The result has been a perfect record of revenue growth over the past decade, and a perfect record of earnings growth since the company turned profitable in 2003.  In the most recent quarter, revenues grew 21% to $58.6 million, while earnings grew 19% to $0.32 per share.

Paul Goodwin, editor of Cabot China & Emerging Markets Report, recommended the stock to his readers back on May 14, when it was trading at 37, writing:

“It used to be that when Chinese families traveled, especially for Chinese New Year and other holidays that required long journeys, they would just get off the train in their destination city and then start looking for a place to stay.

“There’s probably a lot of that kind of non-planning still going on, but the Internet and Ctrip.com have changed things a lot.

“At the heart of Ctrip.com’s success is its excellent Web site. If you go to http://www.ctrip.com, you will arrive at a page that asks you to choose your language, with the choices being Mandarin, Cantonese and English. The layout is clean and easy to understand, with tie-ins to packages, car rentals and the company’s award-winning call center.”

But the fundamentals are only part of the picture; all Cabot growth stocks need to possess promising charts, as well, indicating strong sponsorship by institutional investors.  Paul wrote:

“The chart for CTRP shows why it was one of the early stars among the Chinese stocks. CTRP was trading at 6 on this date in 2004, then soared for four years to 71 on May 5, 2008. The stock’s tumble to 16 in November was painful, and flew in the face of the company’s continuing growth and profitability. The recovery didn’t really get into gear until March, when CTRP finally bolted out of its base with support at 20 and headed upward. The stock worked its way up slowly, finally chewing its way through 30 and all the way to 35 before earnings came out.

The earnings report gapped the stock up to as high as 43 before a normal correction set in. CTRP still hasn’t filled the gap, and is holding up nicely at around 37, with the 25-day moving average still below 30 and the 50-day under 27. All in all, this looks like a good setup for a vigorous company with an enormous potential market and a reasonable P/E ratio of 30. There may be some overhead from last year’s owners who still hold the stock between 40 and 50, but with a good earnings report and a couple of analysts’ upgrades under its belt, CTRP’s prospects are excellent. BUY.”

Since then, the stock has climbed to resistance at 48 again, and pulled back (in market weakness) to its 50-day moving average at 40.  I think it’s a high-potential set-up, but if it goes wrong, stops under 39 should keep losses small.

Yours in pursuit of wisdom and wealth,

Timothy Lutts
Cabot Wealth Advisory

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