Despite a flood of investment leading up to the 2008 Olympic Games, economic conditions in China have been on the decline for the entire month of August, leading some analysts to warn of a post-Olympic slowdown. But the Chinese economy so far has proved resilient, and with policymakers in Beijing scrambling to ensure economic growth, it will likely escape a significant downturn.

The Shanghai Stock Exchange’s Olympic event was diving. The Shanghai Composite Index dropped roughly 12% between the opening and closing ceremonies of the games. It’s now down about 60% from its October high. The steep drop came as a harsh surprise to many Chinese investors who were expecting the Olympics to be a boon for the economy.

"Everybody said the market would turn [positive] in July before the Games, so we listened and stayed in it," one trader told the Los Angeles Times. "In July, they said that the market’s spirit would return when the Olympics came. What spirit is that? Now we are all dead and have no spirit left in the market."

There is no single explanation for the index’s decline, but it can mostly be attributed to a rash of data that suggests China’s high-flying economy is beginning to wobble in line with a global downturn.

"Recent data suggested that the slowdown has taken a firmer hold of the economy and the Olympics may present some downside risks," Citibank economist Ken Peng said.

China’s industrial output slowed to a 17-month low in July as weakening exports hit factory production across the nation. Industrial production grew by 14.7% in July, down 16% in June and 18% percent in July of last year, the National Bureau of Statistics reported.

"The deceleration in export growth was the main reason for the slowdown in industrial output," the bureau said, adding that export growth for the month was 26.9%, compared to 34.2% in July 2007.

Also, producer price pressures remain high even though consumer prices that climbed to a 12-year high of 8.7% in February receded to a 6.3% increase in July. Increased costs for labor, energy, and commodities caused producer prices to jump 10% from a year earlier in July – an indication that corporate profit margins are caught in a vice.

China’s gross domestic product (GDP) growth now has decelerated for four consecutive quarters. China’s GDP grew 10.1% in the second quarter, after expanding by 11.2% in the fourth quarter of 2007, and 10.6% in the first quarter of 2008.

GDP growth is expected to slow even further as economic conditions throughout the world continue to deteriorate. Standard Chartered Bank has said China’s rate of growth will slow to 9.9% in 2008 and 8.6% in 2009. China’s economy grew 11.9% in 2007. 

Those rates of growth may still sound impressive but a nation as large as China needs economic growth to come along much faster than its Western counterparts.

"China needs much faster growth than an average Western country as it has to generate 10 million jobs a year," Tao Dong, chief Asia economist at Credit Suisse Group AG (ADR: CS) told Bloomberg News. "Eight percent growth in China is equivalent to a recession. Below nine percent would make the authorities quite nervous."

Mingchun Sun, China economist at Lehman Bros. Holdings Inc. (LEH) says GDP for the second half of 2008 will slow to 8.7% in the second half of 2008, and just 8% for all of 2009.

"If growth goes lower than 8% the government will be very worried," says Sun, who sees only 2 million jobs being created. "This is important because unemployment is related to instability."

Central Bank Shifts its Stance

The government is already worried. But unlike U.S. policymakers, Chinese authorities actually have the firepower to fend off a protracted slowdown.

China has a budget surplus equivalent to 1.5% of its GDP and currency reserves equal to 45% of GDP, according to Credit Suisse. That gives policymakers ample resources to keep the economy churning at a double-digit pace. And the government seems fully intent on promoting growth, despite a possible resurgence in inflationary pressures.

"Concerns over China’s export health will translate into a complete reversal of the current tightening of policy," Donald Straszheim, vice chairman of Roth Capital Partners LLC told Bloomberg. "Maintaining economic growth is now number one."

The People’s Bank of China made that very clear in its second-quarter monetary report, which dropped any reference to monetary policy as "tight." Instead, the second quarter report stated the central bank would "make its top macroeconomic priorities maintaining stable and relatively fast economic growth."

Inflationary risks "can’t be neglected," the report noted, but added that "external demand will continue to weaken, and the negative impact on exports, economic growth and employment will emerge further."

That’s a subtle but significant shift from he previous report, released in May, which said the central bank would "place a higher priority on containing price rises and curbing inflation, and implement a tight monetary policy."

In July, the Bank of China followed through by raising lending quotas for national banks by 5% and regional lenders by 10%, potentially allowing banks to extend about $26.3 billion (180 billion yuan) in extra loans over the rest of 2008. Those limits previously had been put in place to crack down on excess liquidity flowing freely through the market.

There is also growing speculation that policymakers in Beijing are assembling a $58 billion (400 billion yuan) economic stimulus package. The package would be equivalent to 1%-1.5% of GDP and aimed at smaller businesses struggling with high material and energy costs, a strong yuan, and withering export demand.

"The top leadership is carefully considering an economic stimulus package," said Frank Gong, chief China economist at JP Morgan Chase & Co (JPM). "This will include tax cuts and measures to ‘stabilize domestic capital markets’ and support ‘healthy development of the housing market’."

A Rebound on the Way

Fixed asset investment is one of the areas already benefiting from the central bank’s new direction. Total spending on mines, factories, and land between January to July shot up 27.3% from a year earlier, while central government investment accelerated 25.3% in the first seven months of the year. 

"The slight increase in fixed-asset investment (FAI) will help alleviate concerns about the magnitude of China’s economic slowdown," said Jing Ulrich, chairman of China equities at J.P. Morgan Securities. "Targeted pro-growth policies, widely expected from the government in the second half, will have a countervailing positive impact on FAI."

The FAI news and anticipation of further pro-growth policies sent the Shanghai Stock Exchange sailing 7.6% on August 20 – the third largest single-day gain in all of 2008. However, the Shanghai composite index lost 45.38 points, or 1.85%, over the week, to finish at 2,405.23 points.

Of course, that doesn’t mean the index will continue its decline. Investors continue to pressure Beijing to intervene, and with the central bank’s renewed focus on promoting growth, intervention – through a stimulus package or otherwise – becomes more and more likely with each passing day.

"New policy measures to support growth could include further tax rebates for low-end exporters, an easing of lending quotas, slower yuan appreciation or even depreciation," Glenn Maguire, chief Asia-Pacific economist at Societe Generale SA (ADR: SCGLY), told Bloomberg. "China is returning to the investment-heavy growth model we saw in 2003 and 2004."

Battered stock prices have also left some real bargains on the floor of the SSE, which could also restore investor confidence. At their October 2007 peak, shares on the Shanghai exchange were trading at prices nearly 53 times their annual earnings, according to Ulrich. Since then, the Price/Earnings ratio for Chinese stocks has fallen to about 18.

News and Related Story Links:

• Bloomberg:
  China’s Economy Slows on Weaker Production, Olympics Closures

• Los Angeles Times:
  Chinese stock market’s Olympic specialty: tumbling

• Wall Street Journal:
  China to Gain Boost From Investment

• Money Morning:
  China Plans $58 Billion Stimulus Package and Rate Cuts as Policy Shifts from Inflation to Growth

• Money Morning:
  How to Profit From A China Investing Strategy

The 85,000-mile relay that will culminate with the lighting of the Olympic torch got underway March 24. The torch will pass through five continents and 20 countries on its way to the Beijing 2008 Olympic Games. But the flame isn’t just leading athletes and spectators to the games, it’s also lighting the way to profit.

Beijing is spending at least $40 billion on venues and related infrastructure, all with the goal of featuring a modern country that has grown into a political and economic powerhouse.

In addition to the government’s own investment, an estimated 3.5 million visitors will be bringing their wallets to the games. More than 60 sponsors, some of which spent $100 million each just to be associated with the Beijing Olympics, also have opened up their checkbooks.

There’s going to be a lot of money flowing through Beijing as consumers, advertisers, and investors alike swarm the city.

Here are a few of the leading candidates to win big come August…

Story continues below…

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Overnight Profits

The number of international visitors to China rose 9.6% in 2007, with close to 55 million arrivals, the World Tourism Organization reported. In that same time, Chinese domestic travel skyrocketed with 1.6 billion domestic trips.

Hotel managers in China saw an increase in revenue per available room (revPAR) of 3.2% in 2007, according to HotelBenchmark Survey by Deloitte & Touche LLC.

The Beijing Tourism Authority predicts the city will be flooded with 3.5 million visitors, both domestic and international, during the games. Hotels and houses for rent are going quickly, and insiders say that rental rates during the Olympics will be 10 times the usual amount. Conscious of the investment opportunity, Beijing residents have been grabbing up as much real estate as possible to prepare.

The average cost of a hotel room in Beijing was $127 a night in 2007. The city’s occupancy rate was 70.8%. And it’s a safe bet that both occupancy, and the cost of accommodations, will be significantly higher in 2008.

A leading economy hotel chain like Home Inns & Hotel Management Inc. (HMIN) stands to reap a tidy profit from the increased traffic that will be pouring through China. Home Inns reported revenue of $135.7 million (989.5 million yuan) last year, an annual increase of 68.1%. The profit margin of the Nasdaq-listed company jumped 43% year over year to $15.2 million (106.7 million yuan) in 2007, its unaudited financial report said.

"While we delivered strong overall financial results for 2007, we did experience increased costs as well as some negative margin pressure during the fourth quarter due to our acquisition of Top Star and our expansion into lower tier cities," Chief Financial Officer May Wu said in the report. "We will continue to make efforts to more effectively manage costs as this effort continues."

The company expects its revenue in the first quarter of 2008 to be in the range of $47 million to $50 million, with full-year revenue growing 70% to 80% over 2007.

The Other Baidu

For 40 years – dating back to 1969, when civilian Internet emerged from a Defense Department project – the United States has had the biggest population of Internet users. But that mantle – like so many others – has been passed along to China.

China has some 225 million Internet users, according to the China Internet Network Information Center. BDA China, a Beijing-based consulting and research firm, thinks that figure is closer to 228 million. Either way, the United States has relinquished its web-surfing crown. And in the next year, another 60 million China consumers are expected to join the online world.

Web portals will be busy as billions of frenzied fans sign on for updates on their favorite events. Baidu.com Inc. (BIDU), China’s leading search engine, will do well, no doubt, but Sohu.com Inc. (SOHU) might be a more unconventional play.

Sohu is a popular provider of online entertainment, information and communication. And it’s the official Chinese portal for the Beijing Olympic Games. Sohu’s fourth-quarter revenue shot up 90% to $65.3 million. Earnings soared 144% to 43 cents a share. Those results easily eclipsed Wall Street’s projected results of 39 cents a share on $55.4 million in revenue.

Advertisers will continue to ratchet up their spending as the Games draw nearer, and Sohu expects advertising revenue to soar by 40% in the first quarter of 2008. Analysts also think Sohu is well positioned to build on its momentum in the next year.

In a note to clients, Goldman Sachs Group Inc. (GS) analyst Leah Hao raised her first-quarter game revenue estimate by $4 million, increasing her total revenue estimate for the quarter to $72.8 million from $68.7 million. She also raised her first-quarter earnings estimate to 42 cents per share, from an earlier estimate of 34 cents per share.

The World’s Largest Clean-up Effort

In addition to beating out the United States to become the world’s biggest Internet user, China has also supplanted the United States as the world’s biggest polluter.

Half of China’s population – 600 million to 700 million people – drinks water contaminated by human and animal waste. In fact, one billion tons of untreated sewage is dumped into the Yangtze River each year.

Just as alarming, both the World Bank and Chinese Academy on Environmental Planning believe air pollution to be responsible for no less than 411,000 premature deaths a year.

Indeed, China’s pollution is so bad that some Olympic athletes will be taking the last possible flights to Beijing to delay breathing in the city’s smog for as long as possible. U.S. Olympians will be bringing their own food out of concern for safety.

Most of the air pollution comes from the China’s coal-fired power plants, which supply 80% of the nation’s energy. The country is home to more than 2,000 coal-fired power plants, and a new one goes into operation every week.

Between 2003 and 2006, worldwide coal consumption increased as much as it did in the 23 years beforehand. China was responsible for 90% of that increase. China used 2.5 billion tons of coal in 2006, more than the next three highest-consuming nations combined.

With its climate-change program, China is working to reduce greenhouse gas emissions by 950 million tons over the next two years. To accomplish that goal, China’s going to have to find a new source of power, and so far nuclear energy seems to be Beijing’s b est option.

In addition to the 11 nuclear reactors already operating in China, the government is looking to build 30 more nuclear power plants. This is the largest nuclear power initiative ever undertaken, and it’s entirely likely that the price tag will exceed $50 billion. For its money, the Republic of China would end up with 11% of the world’s nuclear energy capability.

What does this add up to? Possibly a big run-up in the price of uranium. At the end of 2003, when China first announced its plan, uranium was valued at $15.50 a pound. By June 2007, the price had climbed to $133, a 758% increase. The price has retreated from its peak to a current price of $73.00 a pound. But once China’s newest power plants come on line, and other emerging markets such as India increase their consumption, the price will likely bounce back.

According to the market’s leading journal, The Uranium Market Outlook, the amount of available above-ground uranium is at an all-time low. The journal attributes the sudden dearth to 30 years of underinvestment, increasingly stringent regulations and an overall lack of exploration of uranium deposits. It takes eight years for a mine to be brought up to standards and to start producing uranium of a high-enough grade for use in nuclear reactors.

Cameco Corp. (CCJ) has been called the "Saudi Arabia of Uranium" because it is the world’s largest producer, accounting for 20% of global supply. It’s also straight downstream from a glut of cash contained in a new energy bill that offers $18.5 billion in loans to cover the construction costs of new nuclear plants.

The stock has been beaten down by uranium’s price drop – and a sagging global economy – but was raised to "Buy" from "Neutral" by Merrill Lynch & Co. Inc. (MER) Canada analyst Alka Singh, who wrote in a note that the stock "looks attractive" and may be poised for a rebound. 

News and Related Story Links:

• CCTV:
  Olympics lease investment booms

• Associated Press:
  Sohu Up As Analyst Raises 1Q Estimates

• TradingMarkets.com:
  Sohu Keeps Focus on Ad, Games, and Search

• ARS Technica:
   China now #1 in executions, population… and web surfing!

• Money Morning:
  U.S. Olympians Brown Bag it to Beijing

• Money Morning:
  Gray Skies Are Going to Clear Up: Profiting From China’s Green-Tech Movement

• Money Morning:
  Beijing Games: China’s Olympic Forecast Calls For Clear Skies, Lots of Profits.

• Official Web Site:
  Beijing 2008 Summer Olympic Games.

Sometimes it’s better to invest in the hungry underdog than in the satisfied leader, and nowhere is that more clear than with Pepsi and Coke in China.

In a story that received only passing coverage here in the U.S. market, Pepsi recently ‘went red’ in China – as in Coca-Cola red.

As far as product-introduction strategies go, it’s one of the most brilliant I’ve seen in my two decades of doing business in the Asian markets. And the move speaks volumes about the massive potential that savvy U.S. companies see in China’s quickly emerging consumer market, since it’s such a risky move for Pepsi to make. But it’s the alluring risk-reward ratio we see here that makes this such an intriguing investment opportunity.

In case you missed the story, here’s what’s up.

The Olympics Aren’t the only ‘Games’ Being Played

As part of its big marketing push for the 2008 summer Olympics in Beijing, PepsiCo Inc. (PEP) adopted one of that country’s national colors in creating a red-themed can for sale exclusively in China. The special red can was just unveiled and the resemblance to the signature red cans of archrival Coca-Cola Co. (KO) is both uncanny and startling, according to people I’ve talked with who have seen it first hand.

The can is so striking, in fact, that Chinese shoppers picked up a ’sixer’ of Pepsi in their local WuMart by mistake when they were really after Coke.

[WuMart, in case you were wondering, is one of China's largest retail chain operators - not unlike its Bentonville, Arkansas-based U.S. "mart" counterpart. Some things truly are the same the world over, it seems.]

Why is this red can saga such a big deal? The "blue storm logo" has been Pepsi’s global standard color-scheme, in use since 1996. Prior to that, a Pepsi can sported a signature red-white-and-blue color scheme that was all its own.

But Coke’s cans have been red for as long as I can remember. It’s important to understand that this ‘Coca-Cola red’ isn’t merely a color, or even a trademark – it’s an identity, and is one of the reasons Coke has emerged as a global consumer icon.

In announcing the red can, Pepsi said the move wasn’t aimed at Coke at all, but rather was Pepsi’s chosen way of showing support for China’s national Olympics team. Pepsi also said it got a lot of positive feedback from a survey of Pepsi drinkers who lauded the company for its "bold move," and for its demonstration of respect for its Olympic host.

Besides, Pepsi said that it has adopted a country’s national color for a promotion before (including, once, yellow for a special Brazil promotion). I’m sure that’s true. But in that case, Pepsi wasn’t fishing in another guy’s pond, like Pepsi clearly is with Coke in China.

Pepsi, of course, doesn’t see it that way.

"We are ‘going red’ for Team China," Leo Tsoi, Pepsi’s China marketing guru, said in an interview. "We wouldn’t be doing a program that is simulating the competitor [but has no other benefits, which this one clearly does have]."

Naturally, Coke is downplaying Pepsi’s actions as a form of flattery [in a display of seemingly forced glibness, a Coke spokesman responded to the announcement by saying: "Red? Great idea. Why didn't we think of that?]. And Pepsi has stated that the red cans will go away at the end of the year, which is why I suspect there hasn’t been a "cease and desist" rocket out of Atlanta yet.

[I have to confess, however, that I have my doubts about whether Pepsi will actually squelch this packaging promotion at the end of the year, if it ends up proving successful, as I suspect strongly that it will].

Playing by the Rules – China Style

Having watched many western brands enter the Asian markets over the years, my take is that Pepsi caught Coke absolutely flat-footed here. It would also appear that Coke has been ‘out-Chinesed’ by its top Western competitor, since Pepsi has seen how a number of products were marketed with a "wrapper" that mimicked a highly successful Western counterpart.

After all, we’re talking about the land of ‘Hondga’ Motorcycles, ‘Redberry’ communication devices and countless other brands that approximate their western counterparts through imitation that’s not identical but which is a little too close for comfort.

And the challenge is even greater in a product sector where the wares are essentially commodities, says Professor Eugene Fram, a well-known expert on global marketing.

Although Coke and Pepsi would argue that they’ve differentiated themselves from one another – and from any other rivals – via differences in taste, packaging and brand equity, Fram says studies show that carbonated drinks are actually ‘commodity’ products, meaning substitutions are easy and frequent, and buying decisions often revolve around product availability, price or even coupons.

"The so-called ‘Cola Wars’ have been going on for decades and decades – they’ve even been the subject of several Harvard Business School case studies," said Fram, the J. Warren McClure Professor of Research Marketing at the Rochester Institute of Technology College of Business in Upstate New York. "In cases such as that, it’s important for the product manufacturer to do whatever they can to differentiate themselves and to attract consumer attention – whether that’s through packaging," or through other strategies.

Given that, the risk may be worthwhile, Fram theorizes.

What I find really interesting in all this is that Western companies are supposed to "play by the rules," or at least that’s the implicit agreement between expatriates in the region which is what makes this all the more surprising and audacious.

Speaking of which, you’re probably asking why Pepsi would deviate from tradition and risk product confusion when everybody "knows" Coke is red and Pepsi is blue?

Well that, my friends, is the ultimate question, the ultimate risk and – as it turns out – the ultimate gotcha.

China: The New Consumer Frontier

In China there are 300 million consumers who don’t "know" anything about either soda brand, but who increasingly have the disposable income to find out.

[For another interesting perspective on the emerging Chinese consumer, click here, or at the link below, to read Money Morning Managing Editor Bill Patalon's article about his experiences reporting from China as a working business journalist. He called it: "The Baywatch Effect. It's an eye opener.]

In the eyes of China consumers, Pepsi might as well be the "red can drink" – essentially usurping Coke’s brand equity and market momentum – which makes the stakes all that much higher in China than in other more established markets.

After all, according to marketing research conducted by RIT’s Fram, Chinese consumers are among the most fickle the world has ever seen but, in an interesting twist of irony, they are also among the most loyal if you can catch them.

And that’s really what this game is about…. catching customers who have never before seen let alone established pre-conceived notions about the Pepsi brand … or any other product for that matter.

And Pepsi, not Coke, was shrewd enough to realize it had to "shake things up" a bit in a market where Coke holds 51% of the soda market, to 30% for Pepsi, according to 2006 figures from the trade journal, Beverage Digest.

But the sales growth is enough to pop anyone’s lid. Coke last year sold 4.33 billion liters of carbonated drinks in China, a sales-volume jump of 70% over its results in 2000, according to market-researcher Euromonitor International and The Wall Street Journal. Pepsi sold 2.93 billion liters last year – 32% less than Coke but 93% better than it did in 2000.

In other words, Coke has nearly double the market share. But Pepsi has nearly double the growth rate. That makes Pepsi a hungry underdog if ever I’ve seen one.

So how do you latch on to your own personal Pepsi campaign when it comes to China?

Simple.

Take a page out of the same playbook and concentrate on the hoi polloi like Pepsi has.

Better yet, buy Pepsi (PEP) shares for the long haul.

Pepsi Cola is part of a global family of top-quality food-and-beverage brands that also includes Aquafina water, Lipton, Tropicana, Gatorade, Frito-Lay and Quaker Foods – all of which are excellent candidates for the quickly evolving Chinese consumer markets.

PepsiCo had total 2006 sales of $35 billion, and the company’s product portfolio has 17 brands that each generates at least $1 billion in annual sales. It’s also well diversified internationally. In its fiscal second quarter ended June 16, for instance, per-share earnings rose 16% to 94 cents – beating Wall Street’s estimate of 89 cents – thanks to an extremely strong performance abroad. Net profits climbed 13% to $1.56 billion.

The company reports its third-quarter results on Oct. 11.

Pepsi Chief Executive Officer Indra Nooyi seems to be very innovative leader. She’s always on the prowl for acquisitions that will "add value," and dismisses the big blockbuster deals unless they’ll do the same. So many executives love those deals because it makes them appear as a "Master of the Universe," and because they’re typically retired and living off their huge golden parachute by the time the deals have left the "successful" suitor in a shambles.

Nooyi has made healthy products and environmental initiatives a key plank of her corporate administration – but again, only where it makes sense. In April, Pepsi made the largest-ever corporate purchase of"renewable energy credits" – enough to offset all electricity used in PepsiCo plants.

Although Pepsi is the world’s No. 2 soft-drink company, Coca-Cola has at times found itself having to play from behind. In June, for instance, Coke said it would buy VitaminWater-maker Glaceau for $4.1 billion, a move that was viewed as Coke playing catch-up to Pepsi in the non-cola drinks realm.

But it’s definitely Pepsi’s very clear commitment to winning in China that gets our vote.

Other good examples of companies doing the same thing include MGM and Dubai, which are both running hard to attract the burgeoning middle class.

By the way, before we wrap up, just in case you want to see for yourself what Pepsi’s red can looks like, here’s a Pepsi Ad for its China Olympics Campaign, Featuring the Change From Blue to ‘Red.’

News and Related Story Links:

• WSJ.com:
  Pepsi Steps Into Coke Realm: Red, China.

• Video TV Ad:
  A Pepsi Ad for its China Olympics Campaign, Featuring the Change From Blue to ‘Red.’

• BrandWeek.com:
  Pepsi Seeing Red in China.

• Professor Eugene Fram:
  The J. Warren McClure Professor of Research Marketing.

• Rochester Institute of Technology:
  The E. Philip Saunders College of Business.

• Money Morning Investment Analysis:
  The Baywatch Effect: Can China’s Growth Help Gold Prices Triple?

• The Wall Street Journal:
  PepsiCo to Webcast Conference Call and Slides on Third-Quarter 2007 Earnings [on Oct. 11 at 11 a.m.].

• The San Diego Union-Tribune:
  PepsiCo 2nd-Quarter Profit Rises, Boosts Full-Year Earnings Forecast.

• Money Morning Investment Analysis:
  Here’s Why MGM is a High-Profit Play on China.