Is Now the Time to Invest in China?

New data suggests that the froth on top of China’s red hot economy is starting to die down, allowing value investors a possible entry point to ride the economy back up. But there is a chance that the country is still in the first stages of a slow decline, which could cost investors dearly.

China’s Lackluster Growth

Since 2007, China’s economy has experienced a slowdown in its breakneck growth. But a slowdown in China means that growth has gone from double digits (14.2% in 2007) to high single digits (estimated 8% for 2012).

While that is seven to eight times the expected GDP growth rate Germany is expected to report this year, China’s seemingly lackluster growth rate has become worrisome for many investors who have parked their money in the country.

That’s because while China’s growth rate is still relatively strong compared to that of Western economies, it is lower than the lofty expectations investors had pinned on the country during its mega-boom years before the credit crunch.

Ramping Up Spending

Since the downturn of the global economy, China’s government has tried to prop up its own economy by ramping up spending. The central bank of China also responded by flooding the market with Yuan to encourage spending.

While that seemed to hold the economy together for a while, the impact appears to be wearing off.

Chinese investors and businesses have started to take note. This week the Central bank of China released the latest data on capital inflows and outflows into the country. It showed that China’s banks were selling more Yuan than they were buying – around 3.8 billion Yuan or around $600 million.

Which essentially means that Chinese investors, exporters, banks and businessmen would rather hold on to the foreign money they acquired through trade and other sources rather than convert them into Yuan.

This is important as it shows that the Chinese do not think their currency is as safe or as strong as foreign currencies, namely the US dollar. It also means more Chinese are taking their money out of the country.

It all may seem esoteric but it is an important gauge of Chinese investor confidence.

During the days of the economic boom, the Chinese couldn’t wait to turn their dollars into Yuan, as they believed their currency was inherently stronger than the dollar and was therefore worth more. That meant more Yuan was circulating through the Chinese economy, leading to the creation of asset bubbles.

Real Estate Bubble

One of the most inflated asset classes during that time was the property market. In Shanghai, for example, real estate prices increased 150% from 2003 to 2010. In Tianjin, a satellite city of Beijing, more prime office space was built during the boom than can be absorbed for an estimated 25 years.

The asset bubble spilled over to everything Chinese, from Chinese stocks to Chinese debt – all was seen as overvalued. But prices have finally started to come down as all the hot money that originally inflated the Chinese investment bubble has left the country or is no longer being created through foreign exchange conversion.

Property prices are finally on the decline and have become more affordable for people. While prices are still high in major cities like Beijing, they are still way down from their top highs.

At one point during the bubble, the price of a property versus the average income for a person in Beijing was 27 times, which is astronomically high. That number has since fallen to a far more sober 12 times.

Stabilizing Equities

The same can be seen in equities, too. The Shanghai composite index hit 6000 in 2007 and has since fallen to around 2100. It is down around 17% from just last year and appears to be stabilizing.

Analysts are now giving the thumbs up to Chinese stocks. Rob Aspin, Head of Equity Strategy at Standard Chartered, said in a recent report that equity valuations for Chinese companies are now “cheap.”

Is it the Best Time to Invest in China?

It is hard to say.

There are a lot of moving parts to consider – both political and economic. China’s government seems determined to do everything it can to prop up the economy, from lowering interest rates to flooding the money supply with fresh Yuan.

In any case, each property market and each stock has its own valuation that should be studied carefully before investing.

While some Chinese stocks make be “cheap” relative to where they were trading during the boom years, the price may be justified when looking at their future income prospects. The company may not be earning enough cash or is simply a dud. Things like corporate governance and investment restrictions should also be considered when investing in China.

But it is hard to ignore the demographics of China, with its population of 1.3 billion. Average incomes in the country are rising, allowing Chinese people to buy more of the goods they are currently creating solely for export.

Eventually, it is hoped that China will not be as dependent on exports to fuel its economic growth. That means those idled factories that were exporting goods to the West can be turned back on to make goods for Chinese consumers.

If that’s the case, with its markets beaten down, now could be the perfect time to get in bed with China.

Cyrus Sanati is a frelance financial journalist whose work has appeared in dozens of leading publications, including The New York Times, BreakingViews.com, and WSJ.com. Follow Cyrus on Twitter @csanati