Bullish on China?

By Jason Zweig

Right now, investing in China is hotter than a pot of green tea. Sure, Morgan Stanley Capital International's China stock index suffered a 9% setback in mid-April, but it has still gone up 72% over the past 12 months. In January and February alone, some $320 million poured into U.S.-based mutual funds invested in China. The bullish case for China seems irresistible: a stable government, millions of aggressive entrepreneurs, plenty of cheap labor and 1.2 billion consumers eager to fulfill a lifetime of pent-up demand. But don't be blinded by hype. Here are the important questions:

--HOT OR OVERHEATED? China's economy grew 9.1% last year, nearly triple the U.S.'s rate. China's demand for raw materials such as oil and steel is insatiable, and companies are ravenous for bank loans to finance their expansion. China's central bank boosted interest rates in April, but there's still the risk of an explosive burst of inflation that could cripple economic growth. Even if inflation remains in check, says economist Donald Straszheim, China is likely to face severe blackouts as its inadequate electrical grid struggles to supply enough energy to power the economy.

--FAR EAST OR WILD WEST? "When you're in China," says Hhu Ng, a portfolio manager at the Cundill Group in Vancouver, "you fear for your life sitting in a cab because there's no regard for traffic laws. How much confidence should you have then in China's business laws?" Not much. Corruption is rampant, copyright and patent piracy is a way of life, regulation of the financial markets is murky, and Chinese accounting standards could turn the con men of Enron and WorldCom green with envy. What's more, the Chinese banking system is dominated by the government, with loans tending to go to political cronies, state-owned companies and other iffy borrowers.

--GROWTH OR VALUE? Riad Younes of Julius Baer International Equity Fund warns, "When everybody's excited about an investment idea and everybody's chasing the same goose, nobody ends up making money." That's because the return you get out of any investment depends not just on its future growth but also on the price you had to pay to get in. And the Chinese stock market, at least for now, is dangerously overpriced. There's nothing wrong with having an indirect stake in China through a diversified, low-cost foreign fund like T. Rowe Price International Stock, Vanguard Total International Stock Index and the global fund that Younes runs. But buying Chinese stocks or a China-only mutual fund could give you a scalding if the teapot suddenly boils over. --With reporting by Carolyn Bigda

You can e-mail Jason, a money columnist, at investor@moneymail.com

With reporting by Carolyn Bigda