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Why investors shouldn't give up on China

For most of 2015, the U.S. economic recovery has been shadowed by the ongoing slowdown in China. But just how troubled is the Middle Kingdom and, for investors, how much alarm is appropriate?

Although China isn't out of the woods yet, there are glimmers of light amid the gloom. Chinese equities are on the move higher, rising above their 50-day moving average on Friday for the first time since June in what's the first sustained uptrend since May. The economic data is also looking better.

For optimists, in short, the fear surrounding China's economy could present an opportunity. The People's Republic said Monday that its gross domestic product for the third quarter grew 6.9 percent. Although that amounted to the slowest rate of growth since 2009, it just topped analyst forecasts of 6.8 percent for the period, suggesting that the economy may have found smoother air as the government tries to bring the economy in for a "soft landing."

Within the data, meanwhile, there is evidence that Beijing's effort to re-balance its economy away from manufacturing and infrastructure investment to service-sector activity is well underway.

Jack Lew: China must "open up" 01:03

Notably, retail sales growth in China is edging higher. Real estate activity is picking up as well, with the amount of new floor space under development surging to levels not seen since late last year. In another trend highlighting the growth of China's consumer economy, many Chinese tourists shied away from crowded domestic destinations during the National Day Golden Week holiday in early October and instead traveled abroad -- visits to Japan, Thailand, and Korea surged at annual growth rates of 30 percent or more.

China's services sector grew a robust 8.4 percent in the third quarter and now accounts for more than half of the country's economic growth, according to SG Global Economics.

Along with concerns regarding a deceleration in the world's second-largest economy, another reason investors are nervous is the widely held view that the People's Republic overstates its growth. Although economist Julian Evans-Pritchard of Capital Economics echoes those concerns, he writes that the research firm's gauge of economic activity in China has stabilized.

Further evidence of an upturn is visible in the way raw material imports are bouncing back, with imports of copper growing on an annual basis over the past three months for the first time since the summer of 2014.

Stocks in turmoil as China devalues currency 01:37

"With stronger fiscal spending in the pipeline and credit growth accelerating, we continue to see some potential upside to growth over the coming quarters," Evans-Pritchard said in a research note.

Chinese policymakers have responded to the weakness with new measures to stimulate economic growth. A move in August to devalue the country's currency already seems to be having a positive impact on China's trade balance and export growth.

On October 11, the People's Bank of China expanded a refinancing pilot program for banks to nine provinces and cities including Beijing and Shanghai, allowing lending to borrow from the central bank using loan assets as collateral. This is seen as China's version of monetary easing deployed by the Federal Reserve, Bank of Japan, and the European Central Bank in their efforts to boost capital markets and juice their economies.

To be sure, China's economy is losing momentum, although that is partly by design as the country's leaders move to put it on a path for more sustainable growth. Recent signs that all is not well: a fall in auto sales in car-crazy China and a warning earlier this month by Yum Brands Inc.(YUM) that the restaurant giant's sales in China are slipping. (Indeed, the owner of the KFC, Pizza Hut and Taco Bell fast-food brands said Tuesday that it plans to spin off its China business into a separate, publicly traded company.)

Still, assuming the Fed delays its rate liftoff to March 2016 or beyond -- as the futures market currently expects -- the relief rally in Chinese equities and a rebound in the country's economy should continue as its currency stabilizes, limiting "hot money" outflows. Commodity prices should improve, and exports should keep growing thanks to steady demand from U.S. consumers.

For U.S. investors looking to get in on the turnaround, keep an eye on the iShares FTSE China Index Fund (FXI), which has posted an upward cross of its 20-day moving average over its 50-day moving average -- a confirmation of a medium-term uptrend -- for the first time since early April.

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