China’s V-Shaped Recovery

China’s economy delivered strong GDP growth for the second quarter of 2009, expanding 7.9 percent from a year ago–a sharp rise from the 6.1 percent logged in the first quarter. This performance leaves no doubt that China will grow its GDP by 8 percent this year, giving credence to my longstanding forecast in the Silk Road Investor. 

June retail sales increased 15 percent year-over-year, slightly lower than the 15.2 percent growth posted in May. Meanwhile, fixed-asset investment jumped  35.3 percent compared to the previous year; last month this number increased 38.1 percent. Industrial production expanded 10.7 percent from year-ago levels, returning to double-digit growth  in the wake of weaker inflation.

A closer examination of China’s GDP numbers reveals a slightly different picture than many analysts had expected. Consumption contributed 3.8 percentage points to overall GDP, while investment and inventory contributed 6.2 percentage points.  Net exports, on the other hand, contributed negative 2.9 percentage points, demonstrating that exports, though important, are no longer the main engine of Chinese growth.

In other words, the Chinese recovery is taking a much broader form as it expands to other sectors of the economy beyond those levered to gonvernment-sponsored infrastructure projects.

But a lot of market observers point out that China will have to start tightening monetary conditions soon–otherwise the economy could spin out of control. Although this is a legitimate concern, I suspect that Beijing will err on the side of liquidity rather than risk a relapse. My take is that the government won’t do anything drastic before the first quarter of 2010, especially once the authorities start to see solid job creation numbers.

That said, a lot of investors still doubt China’s ability not only to deliver strong economic growth, but also to sustain it. From a market perspective, that there’s lingering doubts regarding China’s ability to deliver quality growth should prove a big cartalyst later in the year; even the most skeptical investors will buy once they have definitive proof that the country’s economy’s economic growth is solud, the currency is stable and asset prices are rising. Expect this scenario to materialize no later than November of this year, when the willfully blind won’t be able to ignore the strength of the country’s economy.

Of course, the biggest question remains how China’s economy will fare in 2010. I expect GDP to grow somewhere in the neihghborhood of 8 percent next year. But if the US and Europe gain a little traction and Chinese exports pick up even moderately, Chinese economic growth could reach 9 percent in 2010.

Investors should seek exposure to the Chinese economy, which has shown the first signs of decoupling from the fate of the developed world and remainds one of the best places to invest in both bad and good economic times.

That’s not to suggest that China isn’t immune to the global economic cycle or isn’t impacted negatively by a slowdown among developed nations. Nevertheless, the country’s economic performance under the current global financial conditions is an early indication that China is in a position to eventually lead the rest of Asia as a new financial order emerges.