ETF Strategist Eric Dutram highlights: If China Slumps, Avoid These Three Country ETFs

Jul 18, 2012, 09:30 ET from Zacks Investment Research, Inc.

CHICAGO, July 18, 2012 /PRNewswire/ -- Funds in this article include: iShares MSCI Hong Kong Index Fund (EWH), iShares MSCI Singapore Index Fund (EWS), iShares MSCI Chile Investable Market Index Fund (ECH).  Eric Dutram looks at three country ETFs that could be in trouble if China continues to slowdown.


If China Slumps, Avoid These Three Country ETFs written by Eric Dutram of Zacks Investment Research:  

For quite some time, China has been a leader in global growth. The country has gone from an economically unimportant nation to one of the leading powers in business over the course of about 30 years. Now, China is the world's second largest economy, the largest exporter, and a key participant in a number of economic meetings and groups.

While China certainly has a long way to go in terms of becoming a developed nation, it is undeniable that its incredible rate of growth and massive economic footprint has made the country a key driver of global economic performance. This is especially true given the underwhelming performance in the U.S. economy and the near recession conditions that are currently plaguing broader European region as well.

Thanks to this situation, fears of a slowdown in China or the bursting of a property bubble have certainly spooked market participants as of late. Several data points regarding manufacturing figures have fallen back to near contraction levels in recent readings while retail sales and non-manufacturing PMI levels have also come in below expectations as of late (read Forget FXI: Try These Three China ETFs Instead).

Meanwhile, property prices in nine major Chinese cities were down close to 5% in a recent year-over-year reading, while unsold housing inventory is beginning to build up to over 20 months in some smaller cities. Given these factors, some are forecasting huge cuts in real estate prices in the near term, a near death sentence for a country that as recently as 2010 was obtaining 13% of its GDP from construction-related activities.

While there is some hope for more Chinese government stimulus to stem the tide, concerns are beginning to build that even a prolonged injection of capital into the nation will not be enough to keep China from a hard landing in which inflation eats up any growth in the massive country (see What Bubble? China ETFs Soaring To Start 2012).

Clearly if this happens, it won't be great news for Chinese ETFs or stocks, and especially those that are heavily dependent on financials and real estate in the region. Yet beyond these directly impacted investments, investors could also see a number of country specific ETFs heavily impacted by a China slowdown as well.

That is because thanks to the China boom, the People's Republic has become a major destination and jumping off point for trade and investment in a number of nations not only in Asia but around the world as well. China's insatiable demand for commodities and finished goods has made the country a top trading partner for many countries that specialize in a variety of goods and services.

In order to determine which countries have become the most vulnerable to a China slowdown, Maplecroft has developed a 'China Integration Index'. This benchmark looks to be a barometer of FDI and trade to see which nations are the most sensitive to economic conditions in China, and thus those that are most likely to be hit by a slowdown in the country. 

By using this index, we looked for the three top ranked—most sensitive—nations that currently have U.S. listed ETFs. Below, we highlight these three nations and their respective funds as ones to watch if China slows down in the near future. If Maplecroft's research is correct, these three ETFs could be among the most negatively impacted by a hard landing in the massive emerging market:

Hong Kong- iShares MSCI Hong Kong Index Fund (EWH)

According to Maplecroft, Hong Kong is the area that is most sensitive to a slowdown in greater China. This isn't that surprising as the city is now a part of the mainland operating under the 'two systems one country' model, keeping its capitalist system but becoming more integrated with the People's Republic.

Thanks to this cooperation with the mainland, Hong Kong does a great deal of trade with the rest of the PROC to the point that it makes up nearly half of both the region's exports and imports. Clearly, a slowdown in China will not only impact this trade but could curtail the large amount of financial activities which take place in Hong Kong and are focused on the mainland.

Given this scenario, investors should definitely watch out for EWH, a fund tracking the broad MSCI Hong Kong index. This results in a fund that has about 40 securities in its basket while charging investors 52 basis points a year in fees (read Hong Kong ETF Investing 101).

Top sectors include real estate and financials which combine to make up more than 50% of assets while utilities, consumer cyclical stocks, and industrials each account for double-digit allocations as well. The product started out the year on a strong note but has since fallen back and is now up just 0.7% on the year although it still pays a robust dividend of about 2.3% in 30 Day SEC Yield terms.

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Contact: Eric Dutram
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