The Party Is Over in China

05/12/2008 12:00 am EST

Focus: MARKETS

John Dessauer

President, John Dessauer Investments, Inc.

John Dessauer, editor of John Dessauer's Investor's World, says China's markets won't recover soon, and investors should focus on multinationals doing business there instead.

I fully expected to tell you that we should buy some Chinese stocks after their recent correction. Alas, this is not so: Our best strategy is still to invest "because of China but not in China."

Starting in 1995, I began writing about the Chinese economic miracle, and I advised buying stocks in companies that were doing business in China. In those days, China was a hard sell to Americans. I was often bombarded with questions about the brutal communist regime. That all changed, not due to any change in Beijing's politics, but due to the greed which followed the spectacular recent gains in Chinese stocks.

From the beginning of 2006 to its late 2007 peak, the Shanghai stock market multiplied sixfold. In the last six months, it has fallen sharply, but its previous meteoric rise lured many investors into thinking that Chinese stocks are the way to profit from China's rapid growth. Investors forgot about the 15 previous years, when the Chinese stock market was a flat-line loser, even as China's economy grew dramatically.

I think the party is over in mainland China stocks. The Shanghai composite index was down to 3,094 on April 18th, about half of what it was at the 2007 peak. It will be interesting to see how all those millions of individual Chinese who rushed to buy stocks on the way up will react now that the market has fallen sharply. My guess is that many will lose interest in stocks and go back to work to earn back their losses.

The number-one reason I have been saying that we should invest "because of China, but not in China" is the lack of managerial talent in China. An entire generation of managerial talent is missing [because of the Cultural Revolution]. China has been making progress with education and training, but the problem is still far from solved.

That brings up the difficult issue of guanxi, the intertwining of personal and business relationships, which leads to what we would call corruption or nepotism. Chinese managers tend to put their personal interests first, ahead of business goals or obligations. This should not be a surprise.

Until Deng Xiaoping's reforms took hold in the 1980s, everyone worked for state-owned businesses. China is a "take care of yourself first" world. Purchasing managers will prefer one vendor over another because they get a kickback. Salespeople buy loyalty with under-the-table gifts and payments.

Yes, China is still an economic miracle in progress. But it isn't easy to transform a nation of 1.3 billion people from centuries of struggle and decades of brutal communism into a successful free market economy. China is still very much an emerging economy, with a long, long way to go.

For long-term investments, choose established companies from the developed economies that are succeeding in China. There are plenty of opportunities.

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