"China has stated its intention to build its own internal consumer-driven demand," says Paul Hechmer, the CIO and founding partner of del Ray Global Investors in Los Angeles. "So it may not be important to own companies that make tennis shoes. It may be more important to own the banks and the companies that benefit more from internal growth."

According to Trippon, China's shift means products of higher value, and thus more skilled manufacturers, salary increases and a bigger middle class. This will have dramatic effects for the surrounding countries as well. With the higher standard of living in China, cheaper labor will shift to countries such as Vietnam, he says.

"What has happened is that manufacturers looking for unskilled labor at low costs have been moving jobs out of China to Vietnam," says Trippon, "and China is actually OK with that. Because what they're looking for is jobs with higher value added, where they can maybe have steel workers get a higher income potential rather than just being a low-cost contract manufacturer."

Long-Term Gain, Short-Term Pain
But while China will inevitably grow in the long term, it's also got growing pains, including volatile stock prices, speculation and overheating. Western investors balk at its opaque business operations, which make the companies hard to value. China gave a lot of money to banks (and unlike the U.S., forced them to lend it, Trippon says). This has led to a too-giddy property market, investors fear.

"There is some overheating in the [property] sector," says Gao. "It is a very important part of the Chinese economy. It accounts for about 25% of the overall economic activity in China. Any significant slowdown or overheating in the sector could have a very big impact on the overall economy." He points to the cities of Beijing, Shanghai and Shenzhen especially as vulnerable, but he says the second-tier cities have seen less irrational exuberance. He also says the government is aware of the problem and has tried to tap on the brakes with tightening measures-stricter lending standards for borrowers, for instance.

The government's willingness to throw hundreds of billions of dollars (more than a trillion with provincial government help) has shored up GDP, but it could also mean a severe hangover as banks find themselves with a lot of loans on their books that won't be paid back, especially for the overheated real estate market.

That has ramifications for Chinese index investors particularly, because financials make up a great deal of the Chinese indices, and these companies are most vulnerable if the Chinese real estate market tanks. "It's pretty much acknowledged around the world that these financials, these banks hold a bunch of real estate that will probably never pay them back," says Hechmer, "So some might say, I really want to be in China, but I don't want to be in the banks."

"We pay no regard whatsoever to the indices," says Sleeman, "And it may or may not surprise you to hear that we don't have a lot of exposure in those areas right now, particularly on the financial side. Our concern on the financials is the lack of transparency in Chinese bank balance sheets. Beyond that, the price of the Asian financials at this juncture aren't cheap enough for us and we're pretty cost conscious."

If the market tanks and financials and property stocks underperform, it would cause longer-term trouble, says Sleeman, undercutting consumer confidence and harming the current Holy Grail of long-term internal consumption growth.
Inflation is also something to be wary of, according to Sleeman, mainly because food makes up a greater part of the inflation index in developing countries like China than it does in developed countries, and food-related items are rising in price because of global droughts and changing Chinese diets. Gao says that even though the CPI is still a reasonable 3.3%, that's a sharp snap back from the negative 2% deflation China suffered in the second half of 2009, and so it's something to be wary of.

How To Play?
The lack of transparency, the inflated stock prices and the unrepresentative indexes mean there's a certain amount of hunting and foraging investors must do if they want to go into China. Most Western investors, barred from investing in mainland China directly, go in through the Hong Kong and New York exchanges. The good news is that it's easier to get transparency that way. But it doesn't make it easy to get into every sector or get a complete snapshot of the long-term Chinese boom.