A Safer China Play

07/07/2008 12:00 am EST

Focus: ETFS

Richard Band

Editor, Profitable Investing

Richard Band, editor of Profitable Investing, says higher fuel costs will pressure mainland China, and he recommends another Asian market he thinks will do well.

For the past five years or so, making money in overseas stocks has been like catching flies with honey. Developed markets, emerging markets, Europe, Latin America, Asia-Pacific, Africa-just about everything was up, and in a big way.

Year to date, [however,] European stocks have tumbled harder, in dollar terms, than New York. Through mid-June, China is down 26% (again, in dollars). India has crumpled 34%. By comparison, America's mid-single-digit losses seem rather tame.

What's going on here? Well, [for one], the Federal Reserve has slashed US interest rates over the past ten months, but many foreign central banks have headed in the opposite direction. Both China and India, in particular, have jacked up rates and taken other steps to crimp the availability of credit. Because of this, economic growth outside our borders is slowing.

I recommend a special degree of caution towards Chinese and Indian stocks, since these two countries will be facing intense financial pressure to backtrack on their fuel subsidies to consumers. In China, for example, fuel subsidies had recently kept the domestic price of gasoline about 40% lower than in the US. Result: The government was running up a staggering tab, projected as high as $70 billion this year.

India's government already raised gasoline prices 10% in early June, triggering riots. China followed suit with an 18% hike on June 19. Expect a rough readjustment for the local stock markets.

If you own any single-country funds focused on China, such as iShares FTSE/Xinhua China 25 Index Fund (NYSEArca: FXI) or Matthews China Fund (MCHFX), I advise you to swap them for a broad-based emerging-markets fund like iShares MSCI Emerging Markets Index Fund (NYSEArca: EEM). Ditto for any Indian specialty funds you may be holding.

Among the other Asian markets, my hands-down favorite is Taiwan. Real GDP (the nation's total output of goods and services, adjusted for inflation) grew at a handsome 6.1% rate in the year ended March 31st, [with] little sign of any let-up ahead.

Analysts estimate earnings for Taiwanese companies will surge more than 20% in 2009. Yet the Taipei stock market trades at a lower forward P/E than the US and a higher dividend yield (over 3%). The currency, too, is still about 15% undervalued against the dollar on a purchasing-power basis, making room for some appreciation from that source.

Your easiest entree is via iShares MSCI Taiwan Index Fund (NYSEArca: EWT). I like EWT for its moderate operating costs (70 cents a year per $100 invested), as well as its exposure to a broad list of Taiwanese stocks that aren't easy to buy in the US.

From its February low, the fund shot up 29%, but has since pulled back into what looks like a promising support area. Buy EWT at $15.50 or less. (It closed below $14 Friday-Editor.) Over the next two years, I'm projecting a total return, including reinvested dividends, of 40%-70%.

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