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Beware the China stock rally

January 15, 2013: 1:16 PM ET
China's stock market has been showing more green than red lately. But it's not clear if the recent rally is sustainable.

China's stock market has been showing more green than red lately. But it's not clear if the recent rally is sustainable.

The opinions expressed in this commentary are solely those of Paul R. La Monica. Other than Time Warner, the parent of CNNMoney, Abbott Laboratories and AbbVie, La Monica does not own positions in any individual stocks.

So much for that China hard landing.

It was fashionable late last year to predict that China's economy was headed for an epic collapse, akin to the Great Recession in the United States a few years ago or the crisis currently in Europe. In early December, China's benchmark Shanghai Composite was reflecting all those fears and then some ... it was trading at its lowest levels in about 4 years.

But Chinese stocks have roared back to life in the past month as economic data have gotten better. The Shanghai Composite is up nearly 20% since it hit its bottom on Dec. 3. Compare that to the United States, where the S&P 500 has gained 3.8% during the same time frame.

If China's economy is really reigniting, that's good news for China and the rest of the world.

Even though China has emerged as somewhat of an economic threat to the United States, especially with regard to trading practices, we must remember that this is a globally connected economy. One reason that China has struggled is because Europe is its largest market for exports. So if China is doing better that could mean Europe is finally on the mend.

Related: Slow China IPO market limits private equity exits

What's more, China is the largest foreign owner of U.S. Treasuries. With China holding more than $1 trillion of our debt, it behooves the United States to have China in good economic standing. The last thing America needs is for China to start selling Treasuries. That could put upward pressure on interest rates, which would be unwelcome at a time when Congress and the President are busy bickering about raising the debt ceiling ... and trying to avoid a possible default and credit rating downgrades in the process.

So here's the good news about China. For now, it seems like China's stimulus initiatives -- particularly the central government's heralded plan to increase urbanization in the country -- should continue to lift China's market for the short-term.

Jordan Kohley, global markets analyst with Lowry Research in Palm Beach, Fla., notes that the current rally in the Shanghai Composite is the most significant during the long bear market for China. With that in mind, he said he's growing more confident that the rebound in Chinese stocks is in fact for real.

And executives from several U.S. companies with exposure to China, most notably Caterpillar (CAT), have talked about how they think China's economy will make a sustainable turn for the better in the first half of 2013. Apple (AAPL) CEO Tim Cook also recently said that he expects China to eventually become Apple's largest market.

Related: Manufacturing expansion accelerates in China

Still, there are some concerns that China's comeback may not last long.

"China's economy is rebounding and that's what is helping the market there. But it's been led by infrastructure spending. It's government led. The problem is that governments have to pay for this spending. The question is how far can the recovery go," said Michelle Gibley, director of international research with the Schwab Center for Financial Research in Denver.

Gibley added that there are questions about the health of China's banking system. She cited a newspaper editorial from last year in which Bank of China chairman Xiao Gang referred to some wealth management products being offered through China's "shadow banking system" as "fundamentally a Ponzi scheme."

Bank of China is one of the nation's largest financial institutions. Xiao's comments would be like Brian Moynihan of Bank of America (BAC) or Jamie Dimon of JPMorgan Chase (JPM) writing in The Wall Street Journal about fraud in the U.S. banking system. So investors can't dismiss the possibility that China's economy still has an element of smoke and mirrors to it.

Related: Food prices boost China inflation

There's also the issue of the Chinese consumer. It's not clear at all whether or not Chinese consumption is increasing or waning. On the one hand, fast food retailer Yum! Brands (YUM), which has flooded the Chinese market with KFC franchises, has recently warned of slowing sales in China. But British luxury goods retailer Burberry (BURBY) reported healthy earnings Tuesday morning and specifically cited improvement in China as one of the reasons for its strong results.

So the jury is still out on the Chinese recovery. But make no mistake. Even if you're miffed about how China keeps its currency artificially low and are worried about how China's economy may be stealing jobs from the United States, we need China to remain on a firm growth path. A healthy global economy begins and ends with a vibrant Chinese economy and stock market.

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Paul Lamonica
Paul R. La Monica
Assistant Managing Editor, CNNMoney

Paul R. La Monica is an assistant managing editor at CNNMoney. He is the author of the site's daily column, The Buzz, and also tweets throughout the day about the markets and economy @LaMonicaBuzz. La Monica also oversees the site's economic, markets and technology coverage.

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