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Why China’s Slower Growth Hurts

For American investors grappling with European debt woes and plenty of uncertainty at home, China may not rank high on the list of concerns. But investing pros say a slowdown in China’s growth could have a bigger impact on portfolios than people may realize.

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According to data released today, China’s gross domestic product grew at an annualized rate of 9.1% in the third quarter. While that’s still higher than most other large economies — the U.S.’s GDP gained an annualized 1.3% in the second quarter (the most recent data available), while Japan’s decreased at an annualized rate of 2.1% — it fell slightly below the 9.2% growth analysts had expected. It’s also slower than the 9.5% growth in the second quarter and 9.7% growth in the first. The bigger concern, says Todd C. Lee, an economist at HIS Global Insight, is that the slowdown could accelerate if exports to Europe and the U.S. continue to fall.

That could be bad news for American investors, many of whom are more exposed to China than they were in the past through foreign stock funds. Investors have poured $15.2 billion into international stock funds so far this year, even as they’ve pulled $36.8 billion out of domestic stock funds, according to Morningstar. In September, emerging markets funds drew most of the inflows to the broad international category, to the tune of $2.7 billion out of a total $3.2 billion.

And these funds’ exposure to China has been growing. The country now accounts for more than 14% of the average emerging-markets fund, double the level in 2007, according to Morningstar. And while the average international fund’s exposure to China is relatively small, it too has doubled — to 3% over the same period.

Some fund managers are making even bigger bets on China. For example, the $47.5 million Dreyfus Total Emerging Markets fund (DTMAX) had about 28% of its portfolio invested in China as of the end of August, according to Morningstar data. Some large-cap international funds, too, have more China exposure than even the average emerging markets fund: The $42.5 million Davis International fund (DILAX), for example, had about 22% of its portfolio invested there as of the end of July, according to Morningstar.

To be sure, China may still be a better spot to invest than other countries or regions. Another report released today by the Chinese government contained some unexpected good news: Industrial production in the country rose at a higher-than-expected annualized rate of 13.8% in September, slightly higher than the rate in August. That monthly figure is a clue to how strong fourth-quarter GDP will be, Lee says. A rate significantly below 13% would have pointed to a sharper slowdown in the fourth quarter, he says.

Of course, stock market performance isn’t just about how fast an economy is growing or even how quickly corporate earnings rise, say analysts: It’s also about what investors expect and whether reality lives up to those expectations. The market reaction will be based partly on how domestic demand holds up, Lee says. Some investing pros are worried that China will see a domestic crisis due to its government policies that inflated real estate values and pushed banks to make lots of loans during the global recession in 2008, when businesses were weak, Lee says.

China’s Shanghai Composite index was down about 2% following the data release, and the Dow Jones Asia/Pacific Total Stock Market Index was also down about 2%.

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