Investing in the Worst Market in the World

Investing in the Worst Market in the World

Step outside America's surging stock market, and you'll find a market that's erased hundreds of billions of dollars' worth of investments this year. That's hard to believe for many, considering just how well the S&P 500 and other major stock indices in the U.S. and even abroad, such as Japan, have performed this year. The S&P's up nearly 20% year to date, anything but a bad performance.

When we turn our eyes to China, however, a different story emerges. According to Bloomberg, the world's hottest growth story has left investors empty-handed this year, as the Shanghai Composite has wiped out almost $750 billion in value across the market since its most recent high. Hong Kong's Hang Seng index hasn't performed much better, underperforming the S&P and other world leaders drastically during the first half of the year en route to big losses, up until its 7.5% bounce in July ended the plunge.

With China's growth slowing and its markets in a funk, is the world's second-largest economy still worth your investment?

High growth isn't enough
To be fair, China's overall economy still growing at an enviable clip. The country's double-digit growth of years past is nothing but a memory at this point, but China's GDP still grew by 7.5% for the second quarter. Comparatively, Japan's economy, one of the brightest stories this year after new prime minister Shinzo Abe injected a massive dose of stimulus, grew by only an annualized 4.1% in its first quarter of 2013. Few nations are keeping up with China's growth, even if the country has slowed down.

For investors and companies that had counted on China's rapid growth of the recent past, however, the country's slump has come with a sharp jolt. Companies such as steelmaker ArcelorMittal, the world's largest steel producer by volume, have counted on China's demand to make up for slumps in the U.S., Europe, and other sluggish regions. In ArcelorMittal's case, China's weakening steel demand has slowed the company's growth, even as the company still projects a 5% uptick in demand from the market. ArcelorMittal and other global giants reliant on China have weathered the storm because of their size and financial strength, but for domestic Chinese companies -- and their investors -- the ups and downs haven't been so palatable.

I've singled out Chinese aluminum giant Chinalco before, but the company's representative of just the kind of risks many Chinese companies and investors face. Beijing's demand for raw materials -- part of the government's global political strategy to secure resources -- has mandated increasing supply from Chinalco and other materials companies such as steel giants Hebei Iron and Steel and Wuhan, two of the world's largest steel producers.

That increase has driven oversupply in their respective markets, and as a result, Chinalco's stock has plunged into painful depths this year, with far too much supply facing weak demand. Shares of Chinalco are down more than 33% year to date, and while Beijing's backed off its production requirements for many manufacturers recently, the company probably will struggle as the aluminum market stabilizes.

Wuhan and Hebei similarly have each seen their Shanghai-based stocks fall sharply year to date as they struggle with oversupply and excess production. China's slowdown has meant less domestic demand for steel and like goods, and Wuhan, Hebei, and their investors can't expect a return to previous growth levels with China's economic outlook hovering around the 7% annual growth mark.

The industrials and materials sectors may show the most visible signs of strain from China's slowdown, but they're hardly the only ones struggling this year. China Merchants Bank's Shanghai shares have lost more than 20% year to date, with the country's cash crunch and rising lending rates, part of a shakedown of the Chinese financial sector that threatens the future of all but the strongest of the country's banks. As Beijing takes a hands-off approach to the banking sector and China's slowdown intensifies, there's a good chance this bank and others could keep struggling as shadier lenders fizzle.

China's energy sector has taken a hit, despite being home to one of the world's largest and most powerful companies, Sinopec . Shares have lost more than 12% despite the company's truly global reach, as the company's chemicals unit has seen sales slump because of China's slowdown and the resulting weaker demand. Even the country's housing leaders have seen shares fall this year despite strong demand, as prices have skyrocketed in the nation's largest cities and squeezed many Chinese citizens out of the market.

With stocks falling across the board, what's an investor to do in China?

China's game changes
One thing's clear: You won't be able to count on China as a magical supplier of rapid growth, the way its economy has done in the past. China's evolving into a slower-growth reality as the country and its population mature. That means you'll have to follow the same rules that have guided the best investing strategy for decades: Look out for the long term and do your homework before jumping into an investment.

The woes of China's banking sector are a perfect example of how weaker, more opaque companies in the nation are beginning to fall. Top Chinese financial companies will weather the country's credit crunch, but Beijing's more than happy to allow shakier lenders to fall if it'll help out the sector's long-term health. That's not just a good policy by the government; it's a strong warning for investors that, like in many markets, it's the best and most financially sound companies and stocks that are most worthy of your investment.

Companies such as Baidu that have shown success and demonstrated marked advantages are the best and safest bets in a new, slower-growth China. Baidu's command of more than 70% of the Chinese search market and more than 50% of the mobile search market bodes well for the company as the country's population urbanizes and grows wealthier, even as rivals have begun to chip away at the company's dominant market share.

Keeping an eye on Beijing's policymaking is equally important, particularly as the Chinese government takes an active role in critical business areas, such as the aforementioned materials sector. State-owned companies such as Chinalco have gotten in their current predicaments partially because of the government's aims of dominating select markets. For investors of state-owned companies such as Chinalco, Sinopec, PetroChina, and others, ignoring Beijing's ownership of these companies is risky gambling at its worst. As China's economy continues to slow, it's critical to watch how the government adapts -- and how those changes will affect your stocks.

Due diligence required
Baidu's an example of how investors can still find great stocks in the Chinese market, even as the world's second-leading economy slows down. In this new and maturing China, however, sticking to the fundamentals of investing and not going after every shiny stock is more critical than ever. If you stay selective about your investments and pick great companies for the long term, there's still money to be made in China.

One way to find great stocks in China is to target international companies that have found success in this massive economy. Take the world's top carmakers: China is already the world's largest auto market -- and it's set to grow even bigger in the coming years. A recent Motley Fool report, "2 Automakers to Buy for a Surging Chinese Market," names two global giants poised to reap big gains that could drive big rewards for investors. You can read this report right now for free -- just click here for instant access.

The article Investing in the Worst Market in the World originally appeared on

Fool contributor Dan Carroll has no position in any stocks mentioned. The Motley Fool recommends Baidu and owns shares of ArcelorMittal and Baidu. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Copyright © 1995 - 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.