Tickers in this Article: FXI, CEO, CHIQ, HAO, PEK, CAF, CHA, DEER, PGJ, GXC
With China now surpassing Japan as the world's second-largest economy, it's hard to ignore the nation's dominance on the global economic stage. China's economy grew at an amazing 12.7% rate in the last quarter of 2010 and finished the entire year up around 10.3%. Exports surged nearly 31%, and the Chinese economy continues to demand more natural resources, high industrial goods and consumer products. However, all this growth is having some unintended consequences. A massive credit expansion has left the Chinese economy with a potentially precarious overabundance of liquidity. Inflation is high and the Chinese property market is red-hot. Beijing has already taken steps to cool the economy, but many investors are worried about the nation's prospects in 2011. Despite all this, China is still a great place to invest. Read on to find out why. (For background reading, see Top 6 Factors That Drive Investment In China.)

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The Growth Engine of the World
China experienced one of the shortest and shallowest recessions of any major world economy. Its quick rebound has left many investors wondering about the nation's future growth. While growth will be somewhat muted in 2011, the nation is still an economic powerhouse, one that is becoming more dependent on domestic consumption. A key part of China's newest five-year plan is to double imports by 2015 and reduce its trade surplus to zero. This will help to release the country from the binds of an export-reliant economy. Chinese domestic consumption has already expanded at an average rate of 15% between 2001 and 2010. With 1.3 billion residents within its borders, its domestic consumer growth almost assured.

In response to rising inflation, China has raised bank reserve requirements seven times and interest rates twice in the last year. While its 4.9% inflation rate is high, it is far below the 20% rate seen in the 1990s, so Beijing still has time to act. In addition, the gains in China's soaring property market reflect the prices in cities like Shanghai. The average Chinese homebuyer is still seeing "normal" prices and the vast majority use down payments of 40-50% on property purchases.

Finally, fundamentally China is relatively cheap. Historically, the nation trades at an average P/E of around 18. Currently, The MSCI China Index trades at 11.5 times forward earnings. This is the lowest forward multiple since 2004. The state-owned enterprise (SOE) heavy FTSE China 25 Index only trades at a P/E of 13.

Adding Asia's Super Power
China's success is a long-term story, so the current round of pessimism about the country makes now a great time for investors to buy in. The iShares FTSE China 25 Index Fund (NYSE:FXI), which tracks some of China's largest companies like oil giant CNOOC (NYSE:CEO) and China Telecom (NYSE:CHA), has proved itself as the institutional investors' favorite fund, garnering the bulk of assets in the space. However, there is more than one way to bank on the Asian Dragon.

With Beijing focusing its attention toward substantially boosting domestic consumption, both the Global X China Consumer ETF (Nasdaq:CHIQ) and Guggenheim China Small Cap (NYSE:HAO) represent plays on China's entrepreneurial economy. Both ETFs include a nice mix of discretionary and technology companies that will benefit from improved spending such as small appliance maker Deer Consumer Products (Nasdaq:DEER).

Investors who are looking for a different route to China may want to look at the two funds that invest in the nation's A-shares. These securities, which can only be accessed by certain international investors under the China Qualified Foreign Institutional Investors [QFII] regulations, provide the purest China plays. The Market Vectors China ETF (NYSE:PEK), which invests in swaps to gain exposure, and the Morgan Stanley China A Share CEF (NYSE:CAF), which owns physical A-shares, can be used for this back-door exposure.

The Bottom Line
China's tremendous economic growth performance in 2010 has left many investors questioning the nation's future. Inflation anxiety, potential property bubbles and a flood of hot money are chief concerns. However, the long-term picture in China is rosy. Investors can use the current round of cynicism to add the Asian Dragon to their portfolios. The preceding funds along with the PowerShares Golden Dragon Halter USX China (NYSE:PGJ) make great additions. (To learn more, check out Top 6 Factors That Drive Investment In China.)

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