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Keep China on Your Radar

Risks will likely be more in the forefront this year, but as long as China can slow its economic growth gradually, there should be opportunities for U.S. investors there and in other foreign markets.

Remember China? Worries that its massive economy is dangerously fragile have flared up among investors from time to time in the last five years, but were mostly dormant in 2017. Strong global growth muted concerns that China would export deflation, spark volatility in currencies and cause a spike in U.S. Treasury yields as it endeavors to slow its economic growth from the torrid pace of earlier this decade.

In 2018, I think concern about China will again be front and center for investors as policymakers continue to try to slow overheated areas of the economy and eliminate excess manufacturing capacity while stimulating consumer spending and reducing reliance on exports. Policy shifts could lead to risks, but also opportunities if all goes well.

There are two key signals investors should watch this year to make sure China’s economy is holding up, and by extension, contributing to the health of foreign markets more broadly. 

First, keep an eye on the pace of China’s growth. Policymakers are trying to slow some sectors of the economy (like housing) and stimulate others (like consumer spending). But their key tool for these aims—slowing lending—could impede economic growth. So far, interest rates have risen and growth remained healthy, helped by a weak U.S. dollar.

Second, investors should keep an eye on capital flows in China. China is the largest holder of U.S. Treasurys with a stake of about $1.2 trillion. If China starts reducing its holdings (or doesn’t step up to buy more as the U.S. issues more debt) that could lead to higher U.S. interest rates. A weaker dollar helps Chinese companies remain competitive.

I believe Chinese policymakers will continue to successfully thread the economic needle, maintaining decent growth while dampening the risks of too much debt and an overheating in segments of the economy. 

Bottom Line: There is upside if these scenarios unfold as we expect. My advice is for investors to take some profits in their U.S. holdings and use the cash to further diversify into Europe, Japan and emerging markets—all areas that would benefit from ongoing economic growth in China. China’s policymakers have managed to defy skeptics thus far and I think that will continue.

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