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China, Chipotle Share a Perilous Burden

It’s not about growth — it’s about expectations

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So what do China and Chipotle (NYSE:CMG) have in common?

I mean, beyond the first three letters of their names, their liberal use of rice and the fact that “consumption” is behind their success the past few years …

If you said impressive growth rates, you’re close. China remains the biggest driver of global GDP growth. Despite a “lower” forecast of 8.2% GDP growth in 2012, according to the World Bank, after a 9.2% rate in 2011, it’s hard to argue that this country is doing anything other than booming. Chipotle’s rise also is impressive, with a five-year earnings growth rate of almost 40%, and a stock price that has soared more than 575% since early 2007.

But beyond the high growth rates, what Chipotle and China share is something more sinister: the burden of unrealistic expectations, and the pressure to keep up unsustainable growth curves.

First, let’s look at China.

Consider that the gross domestic product growth in China was 9.2% last year, slowing from 2010’s 10.4% growth rate. Even in 2009, the country managed to top the 9% mark. The reality is that 8.2% GDP growth for 2012 is indeed considerably better than peers like the U.S., but it’s not historically where China has been.

In fact, if the 2012 forecast stands, China could see its slowest annual growth rate since 2000, when growth was 8%.

Is China growing? You bet. But the problem is that with a high-growth, high-momentum investment opportunity (colloquially called “bubbles”) you have investors who jump in with sky-high expectations. Everyone wants to get in and ride the surge. That builds buying pressure and results in more gains. More investors watch the profits from the outside and decide to jump in. The cycle continues.

Until the music stops, that is. Because nobody wants to be the last one to realize the growth is slowing down. Momentum, after all, can be just as fast on the way down.

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Of course, talk about a “hard landing” or other slowdowns in China is hardly new. The vast majority of investors have begun to adjust their expectations down and already are planning an exit strategy. But it’s worth looking at the last decade of red-hot China growth via four very different companies that all illustrate the China bubble in a different way. They are China Mobile (NYSE:CHL), China Life Insurance (NYSE:LFC), China Petroleum & Chemical (NYSE:SNP) — also known as Sinopec — and the Aluminum Corp. of China. (NYSE:ACH).

As you can see, despite the very different industries these companies represent — and clear divergence after the 2007 peak for China equities — they all have crashed hard. There was life in Chinese stocks back in early 2010, but that seems to just be a “dead-cat bounce.” Even Sinopec, despite a nice 16% gain in the past six months on rising crude oil prices and stronger energy demand, remains well off its peak.

The takeaway: During the bubble, these stocks kept going up because they kept going up with no real differentiation between winners and losers. When expectations came crashing back to earth, so did the stocks. Only in the last year or two have we started to see divergence between these disparate businesses — as well we should. The idea of a telecom, aluminum stock, energy stock and financial company moving in lockstep is pretty silly considering the very different business models and risks.

By now I’m sure you’re wondering what all this has to do with Chipotle.

Well, the first connection I’d like to make is that the idea of momentum investments isn’t limited simply to China. Wall Street is littered with the carcasses of high-growth stocks that stopped growing as fast as their investors hoped, leading to painful crashes. Think Crocs (NASDAQ:CROX) or Netflix (NASDAQ:NFLX) for recent examples — or more particularly, think of the many fad restaurant chains that see big growth as they expand and then hit a wall after they can’t open up shops fast enough to sustain momentum.

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Four stocks in particular I’d like to show are Krispy Kreme (NYSE:KKD), Red Robin Gourmet Burgers (NASDAQ:RRGB), P.F. Chang’s China Bistro (NASDAQ:PFCB) and Cheesecake Factory (NASDAQ:CAKE). Those with discerning palates or business sense will recognize that all of these chains have different brand identities, customer segments and other unique features.

However, the one thing that they all share is that after a few years, they hit critical mass — and crash.

Article printed from InvestorPlace Media,

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