In terms of the emerging market space, China is certainly the 800 lb gorilla (or in this case dragon) in the room. Seen as one of the key drivers to future global economic growth, investments in the nation have surged over the last decade. However, that surging interest is not without concern. High inflationary pressures, property bubbles and Europe's debt/economic woes have certainly placed a damper on the nation's perma-bull thesis.

Pundits and analysts now debate whether the Asian superstar will see a hard or soft landing for its economy. So far the market has bet on a rebound and a soft landing scenario. For investors, China still represents one of the better long term opportunities and recent positive actions help support owning the nation in a portfolio. (For related reading, see What Is An Emerging Market Economy.)

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Moving Towards a Soft Landing
Chinese stocks have rallied in 2012, as Beijing has taken steps to encourage growth. The nation's broad stock market index, The Shanghai Composite has rallied 7.6% this year. Unlike the massive stimulus Chinese officials launched in 2008 during the credit crisis, their latest efforts have been milder. In order to release more liquidity into the economy, policy makers have trimmed the portion of deposits that banks must hold in reserve by 50 basis points. In addition, bank regulators in the nation have instructed financial institutions to increase lending activity. Given the fact that the Chinese government has a controlling stake in most of the major banks, lending policies have an immediate effect.

Inflation in the nation did rise to 4.5% in January, or a gain of 0.4%. However, the measure of consumer prices is still below its July peak of 6.5%. Analyst's blame the uptick in inflation as a temporary blip related to the Lunar New Year; prices often rise during the holiday due to heightened demand for goods and services. Overall, the broader trend is that inflation is cooling in the nation. For the Chinese government, these lower inflation rates give it more flexibility to grow its slowing economy. As growth in the developed world stalls, Beijing can really begin the process of easing and stimulating domestic consumption again.

Finally, China may be seeing cooling of its red-hot housing market. Previous policies, which included higher down payments, bans on third-home purchases, and placing limits on bank lending, may have finally taken effect. Recently, The Wall Street Journal reported that 70 Chinese cities saw property prices head lower through December and into January. This was the third consecutive month of property price declines. (For more, see An Evaluation Of Emerging Markets.)

Betting on the Dragon
While GDP growth for China will be slower in 2012 versus previous years, the 7 to 8% that it should see will be better than anything found in the developed world. For investors, now could be the time to take a calculated bet on the Asian powerhouse. The iShares FTSE China 25 Index Fund (ARCA:FXI) is the largest and most actively traded Chinese ETF. The fund tracks 26 of the nation's largest State-Owned Enterprises (SOEs), like oil giant CNOOC (NYE:CEO) and telecom China Mobile (NYSE:CHL). However, the fund may not be the best choice. That heavy tilt towards the SOEs gives the Chinese government real control of its underlying holdings. A better broad bet is the SPDR S&P China (ARCA:GXC). The fund's 183 holdings allows investors to bet on more of China and its resulting economic growth minus direct influence.

With inflation and consumer prices beginning to fall within China, domestic consumption will be on the rise. Small caps within the Asian dragon warrant attention as they offer direct exposure to the domestic Chinese economy. The Guggenheim China Small Cap (ARCA:HAO) is the oldest of small cap Chinese ETFs, but the iShares MSCI China Small Cap Index (ARCA:ECNS) might make a better choice. The iShares fund is not only cheaper via expenses, but also features a wider range of holdings. This includes around 30% of assets in consumer-based sectors.

The Bottom Line
Chinese equities have rallied so far in 2012 as its economy drifts towards a more soft landing scenario. As inflation has cooled, Beijing stands ready to stimulate and boost organic growth within the nation. While uncertainty still remains, the potential for China to have good year continues to grow. For investors, broad based funds like the First Trust China AlphaDEX (ARCA:FCA) make ideal ways to double down on the nation's continued success. (For related reading, see The Risks Of Investing In Emerging Markets.)

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At the time of writing, Aaron Levitt did not own shares in any of the companies mentioned in this article.


Tickers in this Article: FXI, CEO, CHL, GXC, HAO, ECNS, FCA

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