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Will FXI and the CAF do well if inflation tames in China?

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insurance August 22, 2011 (Chinavestor) One of the advantages of being a China think tank is that investor tend to ask us the right questions, helping us to focus on issued that are important.  One of them is worth a short brain storming for the benefit of the general China stock investor community. Here is the question: "Do you have any perspective that if the next inflation number shows a sizeable move downward that the govt might hint at relaxing? They are putting their foot down pretty hard and they cannot risk overshooting, especially with the rest of the world looking as bad as it is. Your thoughts?"

The answer is that investors have to pay attention to the iShares FTSE/Xinhua China 25 Index (NYSE:FXI) and the Morgan Stanley China A-Share Fund (NYSE:CAF), among other ETFs. Here is why. Right now Chinese Mainland investors seem to fear more tightening ahead. At least this is what the news seem to suggest after a small slip of the Shanghai Composite Index (SHA:000001) today. If the Chinese will start relaxing, financials will do very well. Right now this is the sector that has been held back the most by administrative measures. Remember, China has lifted bank reserve ration over six times in the past 18 months, holding back banks' ability to lend. This effect their profitability adversely. Actually of of the largest four Chinese banks, China Construction Bank (SHA:601939) just reported RECORD profits thanks to aggressive lending. The Company made RMB92.8 billion ($14.5 billion) profits, or RMB0.37 per share, from RMB70.7 billion yuan, or RMB0.3 per share, a year earlier. This number suggests the banking sector is very healthy in China right now. More earnings will follow soon from Industrial and Commercial Bank of China (SHA:601398) and Bank of China (SHA:601988).

Going forward, if financial relaxation comes, financials will do well and help the iShares FTSE/Xinhua 25 China index (NYSE:FXI), the most liquid Chinese ETF. This ETF is financial heavy weight with over 50% of its assets coming from the sector.

Composition_of_FXI_Aug_2011

Another bet may be the CAF, the Morgan Stanley China A-share Fund (NYSE:CAF). The Shanghai Composite Index (SHA:000001) has a 10%-30% upside easy should monetary tightening come true. Given the strong correlation of the Shanghai Composite Index (SHA:000001) and the Morgan Stanley China A-Share Fund (NYSE:CAF) historically, U.S. investors have a tool to tap into China's stock market growth.

CAF_SHA_2011august



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