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How to avoid a China stock shock

Despite inflation worries , corporate accounting irregularities and drab stock market returns , China’s growth story continues to attract love from Wall Street.

More than 600 mutual funds and exchange-traded funds and nearly 300 companies listed on U.S. exchanges use “China” in their names, writes emerging markets investment specialist Carl Delfeld for Investment U , an investment advisory website. Many of the latter are China-based companies listed as American Depository Receipts.

But beneath the Chinamania is a laundry list of problems. While China’s GDP growth has galloped ahead of the rest of the world in recent years and is projected to continue doing so for the foreseeable future, most of its stock market indices have been considerably less buoyant. Over the last two years, a time when U.S. GDP growth trailed China’s by a wide margin,  iShares FTSE/Xinua China 25 Index Fund rose 11 percent, compared to 43 percent for SPDR S&P 500 .

Investors remain concerned on a number of fronts. At the top of the list: persistent inflation and the Chinese government’s efforts to control it. At the end of June, China’s consumer price index was poised to edge over six percent, something that hasn’t happened since 2008. That increases the likelihood of even tighter monetary restrictions for banks and higher interest rates in the months ahead as the government tries to rein in economic growth.

Opaque financial statements and accounting irregularities among public offerings conducted through a controversial technique called a “reverse merger” are the latest clouds hanging over a growing crop of small-company China stocks that have found their way to U.S. exchanges. Stocks of such companies, which merge with a publicly-traded shell company to gain back-door access to the U.S. markets,  have been under investigation by the SEC for alleged manipulation by short sellers .

None of this, of course, means that the China growth story isn’t real. But for most people, tapping into the long-term expansion of the region’s burgeoning consumer mindset and infrastructure needs through investments that cast a net beyond its shock-prone stock markets is a better bet.

Companies that satisfy the growing Chinese appetite for consumer goods appeal to David Winters, manager of the Wintergreen Fund , whose portfolio has stakes in Swiss watch and timepiece makers Swatch Group and Richemont, the company behind the Cartier brand. “These companies derive about one-third of their sales from the greater China market and are capitalizing on the region’s increasing demand for luxury items,” he says. “Their presence in the region has also helped offset weaker sales in other parts of the word.” They also have strong balance sheets and high levels of management ownership.

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