China's Rebound Is Too Good To Be True

China's markets are doing phenomenally well. China experienced 16.1% increase (year-over-year) in retail spending in October, and consumer discretionary stocks within China's CSI 300 Index have gained 123% year-to-date - the best of any industry. The country's consumer-oriented investments look so perfect that I wouldn't touch them with a 10-foot pole.

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Mixed Messages
On the surface it looks like a no-brainer. Consumer confidence in China is as high as it's been since 2007. More than half the country's consumers think their job prospects for the next 12 months are good, according to China Daily.

Simultaneously, President Obama's agenda with his visit to China this week included a strong request that the country de-peg the Yuan from the U.S. dollar and let it fully appreciate. Coincidentally, that maneuver would also happen to make it easier for China to import more U.S. goods, and make it more expensive to export goods to the U.S. - a 'rebalancing' that Obama was aiming for.

And hey - China's President Hu Jintao even said he'd take measures to reduce China's reliance on exports.

So, that's good news for China's consumer companies, right? Perhaps it's time to finally step into iShares FTSE/Xinhua China 25 Index Fund (NYSE:FXI) or the SPDR S&P China ETF (NYSE:GXC)?

Don't even think about it.

Reality Check
Jintao may have said President Obama's 'rebalancing' is on the way, but considering China also unveiled an anti-ship ballistic missile the day after Jintao was shaking Barack Obama's hand in agreement, I think we can pretty much assume China couldn't care less what the U.S. wants.

And why not? China's interests aren't served by internal consumption, and they know it. Personal consumption only accounted for about 35% of the country's GDP last year (versus the U.S.'s figure of 70%). Worse, only 8% of the country population is considered to have 'disposable income' to any meaningful degree. You can tweak 35% and 8% all you want, but it's still not going to hold a candle to the China's bread-winning industries and export business.

As if that weren't bad enough, there's a vicious catch-22 built into the dilemma. China needs to put more people to work if consumer spending is to improve in any significant way, but to put enough of these workers back into paying positions, the bulk of the new jobs will need to be in the export business or in industrial trades, ramping up production capacity the country isn't supposed to want or need.

In any case, you get the idea. The deck is stacked against the consumer, and in favor of China's state-owned industrial companies. But wait - it gets worse.

Their Own Credit Crisis
Chinese consumers may be spending it, but do they have it to spend?

According to China Market Research and the National Bureau of Statistics it's up 32% in the last year, while credit card debt is up a whopping 130% for the same timeframe. Oh, and as of the middle of the year, credit card debt that's more than two months late was up 133%. (Learn more about consumer spending in Using Consumer Spending As A Market Indicator)

Bottom Line: What Not to Do
OK, the sermon you just went through was recited for a specific investing purpose: to warn of excessive confidence in the iShares FTSE/Xinhua China 25 Index Fund or the SPDR S&P China ETF. The two funds simply pose more risk than most investors realize.

Aside from the fact that China's consumerism is likely to be over-rated, they're both heavy on financial allocations; GXC is 34% financials, and FXI is 47% financials. Both are heavily positioned in China Life Insurance (NYSE:LFC) and China Construction Bank (OTC:CICHY). If China's lending market is already as unhealthy as the data hints, its banks may be bad investments in the very near future - even if they are state run.

Moreover, neither ETF has any consumer discretionary holdings to mention, and as such would serve little purpose as a Chinese consumerism play anyway.

A smarter China play - perhaps the only viable one - may be the PowerShares Golden Dragon Halter USX Portfolio (NYSE:PGJ). It's loaded with industrials and energy stocks like PetroChina (NYSE:PTR) that don't rely on tremendous consumer demand.

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