Bulls should head for China

Headlines warn of a Chinese "hard landing". Don't buy it. China has every incentive to stoke growth in 2012 - which should boost Chinese stocks nicely.

China's growth slowed in 2011, and Chinese stocks lagged. But that shouldn't surprise. China has made big gains in opening its economy in recent years. Still, its political structure remains Communist. It doesn't have democratic elections, but it does have leadership transitions. Officials serve five-year terms - and 2012 is a transition year with changes at every level of government.

With no ability to vote, citizens annoyed with the government can't throw the bums out. Their only outlet is protesting or outright revolution. China's leaders want to avoid that at all costs, so they do what they can to boost growth and keep inflation low - focused primarily on the transition years.

To smooth the way for incoming leaders, bolster the image of outgoing leaders and reduce potential instability, China accelerates its economy during transition years. To do that without also stoking inflation, it usually holds down growth the year prior - just like 2011's deceleration.

You see it in history. Over the last 30 years China's annual GDP growth averaged 9.7%. Fast - but normal for a market that's successfully emerging. Transition years average 11.2% growth - the fastest in the five-year cycle. The slowest growth is the year prior - about 9%. And in 2011, China was clearly slowing growth.

China's central bank doesn't operate like other major developed-world banks. It doesn't allow free capital flows and has a limited bond market, so it controls money supply mostly through bank loan quotas and currency manipulation. Loan quotas are powerful tools allowing China to very directly control economic growth. When China wants to stoke growth, it accelerates loan growth, but also typically allows its currency to appreciate on a trade-weighted basis to avoid overheating. The reverse is true: China slows growth by decelerating loan growth.

And once again, last year, China decelerated loan growth and allowed the yuan to appreciate. Money supply growth rates fell to cyclical lows and inflation fell sharply-leading to widespread fears of a Chinese hard landing.

But in December, China shifted gears. Loan growth in December beat expectations and was the fastest since November 2010. Since September, China has cut taxes on oil production and personal income, cut bank reserve requirements, delayed implementation of Basel's stricter bank regulations and allowed local governments to extend debt maturities - all should boost growth.

And historically, when China accelerates loan growth and lets its currency rise, China typically outperforms emerging markets.

Expect China to keep accelerating loan growth in 2012 and allowing the yuan to rise. And in general, expect global growth to outpace too dour expectations, benefiting economically-sensitive categories and stocks like these:

Oklahoma City's Devon Energy (DVN) is a top-tier natural gas producer facing weak commodity pricing. It also engages in fracking, which is controversial. Many fear an environmentally-led regulatory backlash from Obama's minions in 2012. Fracking is the key to future clean energy solutions. Devon is superbly postured. It has $5 billion (£3.14 billion) in cash, yet at 10 times my estimate of 2012 earnings it is cheaper than many larger-cap peers.

As the world's largest producer of disk drives, Irvine, California-based Western Digital (WDC) was swamped by Thailand's devastating floods in October, severely damaging several of its factories. But it will soon recover better than Wall Street anticipates. Occupy it. It should gain hugely from skyrocketing cloud computing demand. I expect double-digit growth. It sells at 15 times my 2012 calendar-year earnings estimate and 75% of annual sales.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.