Monday, December 16, 2013

Which Stocks to Buy IF China bounces

China remains one of the great imponderables in the investing world. Is it about to roll of a cliff or return to 10%-plus growth rates in the next few years? It's hard to answer these questions, but we do know that the Chinese government is determined to generate more growth in 2014. It's time to look at which sectors might benefit.

China to bounce back in 2014
By now, everyone will have realized that China's growth is slowing. Indeed, the 7.6% GDP growth target that economists have penciled in for 2013 represents the slowest growth in more than 14 years. Interestingly, the OECD predicts that China's growth will improve to 8.2% in 2014 thanks to a "small fiscal stimulus." Essentially, China has responded to slowing growth by initiating a round of stimulus spending, alongside measures to add liquidity into its system.

This time it's different
Old habits die hard, so whenever there's talk of China and spending, many investors simply go back to the mining and energy-based plays that worked so well in the last decade. However, it's different this time. Following its huge stimulus plan in 2008, China now has overcapacity in many heavy industries, including shipbuilding, solar energy, and cement and steel production. In addition, the government is trying to shift the Chinese economy away from its reliance on housing investment and exports (which are slowing anyway due to the current austerity in the West) and toward domestic consumption.

All told, these trends mean that the sectors likely to bounce in 2014 are not the ones we've seen skyrocket before. Indeed, the old commodity plays like Caterpillar and mining-equipment company Joy Global  have been under pressure this year. China's demand for base metals isn't what had been expected. In its latest quarterly earnings, released back in August, Joy Global reported orders down 28% on a constant-currency basis, with aftermarket bookings down 7%. Furthermore, increasing use of gas in the U.S. is holding back Joy Global's core coal market.

Aerospace and autos
However, there are areas of the industrial sector that are benefiting from this economic shift. For example, China's plans involve building 70 new airports in the next few years and expanding 100 existing airports. And if airports are built, routes usually follow. Indeed, a quick look at Boeing's  order book reveals that net orders of 1,054 (to the start of December) represents one of its strongest results in recent years. There is little doubt that Asia has been a major driver of order growth for Boeing. For example, according to the IATA, the Asia-Pacific region will generate 6.6% passenger traffic growth in 2014, compared to 5% in Europe and only 2.5% in North America.

In addition, Chinese car sales have bounced nicely in the second half of this year.

Source: China Association of Automobile Manufacturers.

All of this suggests that aerospace and automobiles will continue to benefit from China in 2014. In this regard, paintings and coatings company PPG Industries  is worth a look. PPG is heavily exposed to the automotive and aerospace sectors, and this year's acquisiton of the U.S. household paints division of Akzo Nobel is well-timed for the ongoing housing recovery.

A word of warning
All told, China looks capable of bouncing back in 2014, but investors need to focus on the long term. There is no guarantee that any stimulus measures or fiscal loosening will lead to tangible return on investment.

It may turn out that China's economy bounces slightly and then slips back again as these investments turn sour. The 2008 investment in industries like steel and shipbuilding could end up simply being mirrored with airports, roads, and transport infrastructure in 2014. Pause for thought.

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