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Is China Back?

There’s a lot of focus on China right now, and with good reason.

Some — including Mohamed El-Erian of PIMCO — are worried that China’s GDP will decline into the 6’s next year, though the “official” estimate appears to targeting 7.5% in 2013. While that sounds like a boon considering the slowdown in the U.S. and Europe, it’s all about expectations in China; consider the MSCI China Index’s 20%-plus decline in 2011 despite a growth rate of more than 9% for the nation’s GDP.

On the other hand, the bulls think expectations have soured so much that valuations are attractive. Furthermore, signs of life in manufacturing and exports indicate that at best China is rebounding from its recent difficulties, and at worst it’s in the process of finding a bottom. Either scenario has the bulls ready to jump in headfirst.

So what’s the real story?

The Bull Case for China

As mentioned, the data is looking up, led by the recent info from China’s manufacturing sector. The HSBC (NYSE:HBC) Flash PMI report just hit a 13-month high, and more important, the reading of 50.4 is the first positive reading in more than a year. (For the PMI index, anything above 50 is growth, while below 50 is contraction.)

Also encouraging is improving conditions for the Chinese steel industry, the largest in the world. The state-run Xinhua News Agency reported that steelmakers will enjoy better conditions this quarter and across 2013 after nine months of losses and poor pricing.

On the broader export front, the trade surplus surged in October at the fastest pace in five months and widened to the biggest margin in almost four years. Fears of a deteriorating trade balance have been persistent throughout the China slowdown, so this is a welcome sign.

The all-important retail sector also is on the mend. October retail sales rose 14.5% over the previous year, topping forecasts. This was after a beat in September, too.

Furthermore, housing prices appear to have stabilized and have begun creeping up once more.

Then there’s the compelling argument that the best time to buy a rebound isn’t after the biggest gains are behind you, but a bit early to ensure you make the lion’s share of the profits. Consider housing stocks, where the focused SPDR S&P Homebuilders ETF (NYSE:XHB) actually drifted down slightly in 2011 … but now is up 75% in the past year. Even if you bought the rebound a year too early, since November 2010 you’d be up 68% in XHB through today — four times the S&P 500.

Or as big-time investor Jim Rogers said in an October CNBC interview: “China’s going to be the next great country in the world. I was violently and vehemently telling people not to buy China when it was going up in 2007. I only buy China when it collapses.”

So whether these data points are truly sustainably yet isn’t as big of a concern to long-term investors as whether a double-dip or deeper trouble is ahead. And at the very least, these rosy indicators show that China is in the process of bottoming — if it hasn’t already.

The Bear Case for China

Reuters just ran a shrewd analysis of the so-called resurgence of Chinese equities with the headline “‘Caveat emptor’ as foreigners rush to ride China rebound.”

The gist of it: Foreign investors have thrown $4 billion at Chinese equity funds in the past two months in hopes of getting in on the ground floor of a big-time rally, but the fundamentals of Chinese markets remain challenging to investors.

Reuters quotes Paul Gillis, professor at Peking University’s Guanghua School of Management, as saying that “most of the problems affecting Chinese stocks — accounting fraud, the variable interest entity and regulatory stand-offs between the U.S. and China — have not gone away and still need to be solved.”

As for housing, while some might think a modest rebound in prices implies stability, there are others that fear this is the continued inflation of a property bubble. Not a month passes by without further indications that Chinese have simply no other investment option other than real estate.

Beyond that, there’s the even bigger issue of China moving away from an economy driven by big-time Beijing investment and cheap manufacturing exports into a modern consumer-driven and high-tech economy.

Consider that a report from the IMF earlier this year notes that Chinese consumption has declined from roughly 63% of GDP in 1992 to just 48% of GDP in 2010. Not a very encouraging sign if the economy is supposedly thriving from a surge in the middle class and a growth of consumer-driven businesses.

Also consider that Chinese technology companies are doing just fine at home playing by Beijing’s rules, but have failed to find a global appeal like tech powerhouses Apple (NASDAQ:AAPL), Microsoft (NASDAQ:MSFT) or Google (NASDAQ:GOOG) have. Sure, home-grown tech stocks can serve the massive Chinese market … but a lack of true private sector “disruption” means these companies have a much lower ceiling than truly global names. If China’s tech sector continues to improve productivity and attract top talent, it ultimately might not matter if it can’t adapt to a very different kind of global consumer.

Oh yeah, and don’t forget competing with Apple’s army of patent lawyers …

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Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at editor@investorplace.com or follow him on Twitter via @JeffReevesIP. As of this writing, he owned a long position in Apple but none of the other stocks named here.

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