Dear Subscriber,

The Shenzhen/Shanghai Index of 300 stocks fell 9.2% last Tuesday.

Why? Because the State Council, China’s highest ruling body, said it started a special task force to clamp down on illegal share offerings and other banned activities. Investors were worried that the government’s zeal could damage the whole stock market.

There’s no question that 9.2% is a big single-day drop. However, just looking at that one day doesn’t tell the whole story. In the previous six days, the same index had jumped 13%. That means that, despite the big drop, the index was still up 3.8% in seven trading days. I’d hardly call that a disaster.

Regardless, a parade of market watchers has been bad-mouthing Chinese stocks, blaming them for the Dow’s plunge, and more. Today, I want to tell you some things that you’re not hearing from these so-called experts.

In short, I want to tell you why the Chinese stock market is very different from the Dow or even European markets ...

Chinese Government Provides
Built-in Safety Nets for Its Stocks

Given all the furious capitalism and all the economic growth happening in China, it’s easy to forget that the country is still a command economy controlled by the Communist Party.

But it is, and that brings with it all kinds of implications that many Western investors aren’t used to ...

First, the Chinese government is the largest shareholder of Chinese stocks in the world. In fact, a majority of the listed companies are state-owned enterprises — China Mobile, CNOOC, China Aluminum, Sinopec Petroleum, Yanzhou Coal, China Life, Bank of China, etc.

The government also controls several of the largest brokerage firms, banks, insurance companies, and pension funds. If the Chinese market falls, the government stands to lose a very substantial portion of its asset value.

Second, the world is watching and Beijing doesn’t want to be embarrassed. The concept of “saving face” may not mean a whole lot in the U.S., but it’s a crucial part of Asian culture. Do you think the Chinese government will stand by idly while its markets go into a freefall now that it has the world’s attention? I don’t.

Government officials certainly don’t want a repeat of previous bear markets when a large crowd of disgruntled investors hurled stones at the Shenzhen Stock Exchange ... or when angry investors protested outside the offices of Beijing regulators.

Third, the government has an ace in the hole that can go a long way to help offset declining prices. If Beijing wanted to prop up the Chinese stock market, it could mobilize a portion of its $1 trillion in foreign currency reserves. Even a small fraction of that war chest would make a significant difference – not only symbolically, but in substance as well.

Fourth, the government still controls the media in China. To a U.S. citizen, this might be disturbing. But it does give the authorities greater control over the flow of news that might impact the market.

For example, after the 9.2% drop in the Shanghai/Shenzhen 300, the lead story on the front page of the Shanghai Daily — the city’s English-language daily — was “Wheat Scientist Wins Top Research Honors.”

Even the lead story of the business section was “Buying Stampede Greets Return of Mutual Funds.” The information about the stock market drubbing was buried in the middle of the paper.

Am I saying state-controlled media is a good thing? Of course not. But as a very practical matter, it helps buffer the markets from the investor frenzy that might otherwise be more likely.

Nor am I saying that Chinese stocks can never go down. They can and they do.

Rather, there are many reasons to expect the damage to be limited. The most fundamental of these: The market’s action doesn’t do a single thing to change China’s juggernaut economic growth.

The same goes for other Asian markets …

Why I Believe the Weakness in Stocks
Across the Pacific Is a Knee-Jerk Reaction

It’s not just U.S. and European markets that fell in the wake of China’s big sell-off. Singapore, Tokyo, India, Taiwan, Malaysia, Indonesia, and South Korea have also suffered.

I believe this is an unwarranted knee-jerk reaction. But it’s also a good thing for longer-term investors. There are dozens of Asian blue chip stocks that have now come back down to levels that look pretty darn appealing to me.

Meanwhile, the underlying economies of these other Asian tigers are growing like mad. Just three examples:

• Hong Kong’s economy expanded 6.8% in 2006, and according to the just-released forecast from Financial Secretary Henry Tang, it should rise between 4.5% and 5.5% in 2007.
• Singapore’s economy gained 7.9% in 2006. The Ministry of Trade expects another 6.5% rise in 2007.
• And the Indian government expects GDP to grow 9.2% in 2007 — the fastest pace in 18 years!

Now, compare those numbers to the U.S.:

Last week, the Commerce Department released its new, revised fourth-quarter GDP numbers. They showed that our economy expanded at a real annual rate of 2.2% in the last three months of 2006. That’s the third quarter in a row of sub-3% growth.

Meanwhile, former Federal Reserve Chairman Alan Greenspan visited Hong Kong last week and suggested that the U.S. economy was headed for a recession.

According to Greenspan,

“When you get this far away from a recession invariably forces build up for the next recession, and indeed we are beginning to see that sign. For example, in the U.S. profit margins ... have begun to stabilize, which is an early sign we are in the later stages of a cycle.”

My point is simple: It’s healthy to be worried about risk. But in my opinion, the riskiest place to invest is in a country with a rapidly slowing economy.

Headline-grabbing declines just sow the seeds to big gains down the road ... as long as you know where to look. Right now, I think many of the juiciest bargains can be found in China’s neighboring countries.

Best wishes,

Tony

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