Main Themes Redux
By Yiannis G. Mostrous
FALLS CHURCH, Va.–Sentiment in global markets remains basically unchanged: It’s a fairly bullish attitude built on expectations for a relatively smooth slowdown in the global economy and, consequently, solid performance for the financial markets. There’s also a secondary view, expressed here previously, that markets will experience more volatility in 2007.
I’ve outlined my perspectives on these issues (see SRI, 10 January 2007, Fiddler On The Roof, SRI, 27 December 2006, SRI, Abridged II and SRI, 13 December 2006, Pushing The Envelope) and won’t repeat them here.
I base strategic decisions on long-held views about economic change; investment recommendations are made according to a particular company’s ability to benefit from these changes. The world economy is going through a transformation, the outcome of which will be a shift in growth leadership. Leadership will be assumed in due course by the East; the process won’t be smooth, but it’s irreversible. The new, rising economic powers will challenge US supremacy, and although the US will remain a very important player in the global economic stage, it will gradually lose its status as the world’s economic hegemon.
A combination of new developments–the rise of China and India, the re-emergence of Russia and the revival of the Japanese economy–are the main catalysts for this new global economic order. Investing in these changes will offer superior results to the patient, well-positioned investor.
A look at the emerging market economies around the world shows not only that these “21st century nations” have experienced strong growth during the past 10 years but that, since the Asian crisis of 1997, Asia’s performance in particular has been stellar and its economies are on a much stronger footing. Ten years ago, these economies had current account deficits; now the majority of them have current account surpluses.
Their share of the global economy has grown from 31 percent in the early 1990s to 38 percent today. Given that their economic transformation is still in the early stages–after all, China’s urbanization ratio is about where Japan’s was pre-World War II–expect these numbers to continue to improve over time.
It’s imperative that you understand and appreciate this dynamic if you’re to make the most of this gigantic shift in the global economy.
Asia is of particular interest because it’s expected to lead economic transformation and growth for years to come. Asia ex-Japan is currently in a long-term bull market that commenced at the bottom of the Asian crisis in 1998 (see the chart below).
Source: Bloomberg
India
India is by far the most exciting growth story among global emerging markets in general and Asia in particular, one I identified as early as 2001.
Although India has never exhibited the same strong growth characteristics as the rest of Asia and can’t match China’s reported growth rates, it’s also avoided the boom-and-bust cycles so prevalent in the region’s developing economies. For an investor interested in achieving serious long-term returns, this fact is of paramount importance.
And because India still represents only 2 percent of global GDP and 1 percent of world trade, it’s been less important to investors, even after accounting for the strong interest shown by investors since 2004. For more on India, see SRI, 25 October 2006, A Genuine Growth Story.
The Indian market has become quite expensive, and it would come as no surprise to see some profit-taking in the near future; I advised long-term readers to take some money off the table at the end of December.
India remains the best long-term story in Asia, short- and medium-term setbacks notwithstanding. Maintain exposure to India, primarily through Dr. Reddy’s Labs and ICICI Bank.
Japan
Japan–enjoying a secular bull market that commenced in 2003–is another investment theme that should develop into one of the biggest surprises of the decade.
As I’ve noted on numerous occasions, I expect growth to continue as the Japanese economy gradually moves out of deflation while consumers return in strength, thus allowing Japanese firms more pricing power. For more on Japan, please see SRI, 14 June 2006, Complications, SRI, 9 August 2006, Look Out Below and SRI, 18 October 2006, Working For Abe.
Recent developments on the monetary front do, however, bear watching. The decision by the Bank of Japan (BoJ) to leave rates unchanged gave an indication to the market that BoJ members are uncertain about the strength of Japan’s growth. More important, though, there’s substantial evidence that the rate decision was influenced heavily by the government because of upper house elections to be held this summer. If true, the BoJ’s reputation as an independent institution would be damaged.
It remains to be seen if Japanese authorities will be able to effectively navigate the economy back to normality (i.e., out of the deflation trap) and allow it to flourish once again. In the meantime, profits and sales continue to grow for Japanese corporations, in the process beating market participants’ expectations.
Taking a look at the narrower stock market picture, it’s obvious that investors have little interest in Japanese stocks. This is in stark contrast to the beginning of 2006, when people–influenced by the strong rally in the second half of 2005–couldn’t get enough of Japan. I’m still positive on the Japanese story, and the market seems to be a good buy given the negative sentiment surrounding it.
I expect to gradually increase exposure to Japan as the year unfolds. Mitsubishi UFJ Financial Group and Mitsubishi Heavy Industries are my current favorites.
Alternative Holdings recommendation Sumitomo Mitsui Financial Group is another way to play Japan.
The banks offer exposure to the domestic economic growth story, while Mitsubishi Heavy is a play on global industrial growth as well as Japan’s effort to re-establish its military capabilities (see Geopolitics & Investing, 8 February 2006, The Dragon And The Eunuch).
Russia
Russia, another long-time favorite, is currently in the sweet spot: It’s a net oil exporter, has good GDP growth, isn’t dependent on foreign capital flows, is relatively stable politically, has reasonable market valuations and, above all, enjoys solid exposure to the biggest growth story of our time, Asia. For more on Russia, see SRI 19 July 2006, My Friend, The President Of The United States, George W. Bush and SRI, 22 November 2006, SRI, Abridged.
Because oil and gas stocks represent 75 percent of the local market, the price of oil is the key for Russia’s performance this year. Although the economy could withstand (and would actually grow comfortably) oil prices at around USD40, it’s obvious that the market as a whole would suffer.
If the per-barrel price slips below USD40, the Russian market will decline. The decline will be more substantial–on the order of 30 percent–the closer to USD30 the oil price goes. And the opposite is true: If the price of oil remains at current levels, the market will be solid. A strong oil price–above USD60–would lead to gains in the Russian market near 70 percent or so.
My base assumption is that oil won’t trade below USD40 this year and that under the right circumstances an average price of USD50 for 2007 is reasonable. The Portfolio includes exposure to Russian energy plays because energy is in a long-term bull market. And Russia remains the only politically stable, serious energy supplier in the world today.
But Russian growth in 2007 will be driven by domestic investment and consumption. Portfolio holding Vimpel Communications is a play on this theme.
Russian politics will be the wild card this year. Russia will hold parliamentary elections next December, a warm-up to the presidential elections to be held by March 2008. Expect President Putin’s party to win the elections, opening the way for his appointed successor to eventually ascend to the presidency.
On the surface this sounds like a Goldilocks scenario. The reality is that the political struggle will be of monumental proportions as the stakes are extremely high. There will be volatility in 2007–political as well as market-related. Those who are able to see through the smoke and concentrate on what really matters for the stock market and the economy will come out on top.
Don’t expect a real crisis to develop; policymakers have been way too prudent, and financial reserves are sufficient to provide Russia with a range of defenses.
Singapore
Singapore has also been one of my main themes in 2006, and it remains so at the beginning of 2007. Although valuations aren’t as cheap anymore, the underlying story remains intact.
Singapore has been on the receiving end of strong foreign direct investment (FDI) dollars, with a lot of this money finding its way to real estate–residences, hotels, malls and offices. The high-end residential area is particularly hot with foreign investors, as they currently account for 60 percent of demand.
This comes as no surprise; in fact, this part of the market should do well in the future, too, as Singapore implements its program for attracting foreign talent to its growing money management industry. This is the main reason prime office rents are rising rapidly in Singapore. In addition, because the government is repositioning Singapore as a “global city” where one can live, work or just have a good time, a lot of rich people are being persuaded by their money managers to buy luxury property in the country. As a result, new luxury buildings are popping up, and the price per square foot has surpassed, in some cases, USD2,000.
Singapore’s effort to position itself as a banking, convention and entertainment hub in Asia is a multi-year undertaking, but observers expect it to succeed. The government has initiated several projects that will result in more than SGD15 billion (USD9.8 billion) in investment in the tourism sector during the next five years.
The Portfolio includes Singapore exposure mainly through United Overseas Bank, Keppel Corp and City Developments. All have performed well, turning in 30 percent gains on average.
I recently introduced two additional themes, infrastructure (see SRI, 17 January 2007, Buying Infrastructure) and Chinese domestic consumption (see SRI, 24 January 2007, Just Fine). Infrastructure-related companies in the Portfolio include Cheung Kong, Keppel, Mitsubishi Heavy Industries, Datang International Power, ABB and Ericsson. The domestic consumption play is Hengan International.
Portfolio Issues
The SRI Portfolio has been constructed around the view that domestic economic demand and investment are driving Asia’s economic ascent. The areas I’m looking at for investment ideas continue to be property, infrastructure, financials, retail, telecom and utilities.
I#ve noted repeatedly that the Portfolio should be viewed as a whole rather than an assortment of stocks. It’s my hard-earned assumption that investors seldom follow such advice, so I occasionally offer some direction in an effort to assist with the decision-making process.
Currently, it’s obvious that Korea, Taiwan and Japan were the laggards for 2006. Investors who like the “beaten down, not beaten up” approach could play this angle. On the other hand, India, Singapore and Russia have done quite well and should be bought on the basis of the longer-term story.
That said, Portfolio recommendations should be taken at face value, in the sense that, if a stock is recommended as a buy and trades below the price indicated in the Portfolio tables, then the recommendation stands for new readers as well as longer-term ones.
Occasionally, I recommend–as I did quite often toward the end of 2006 and the beginning of 2007–that long-term readers take profits off the table. In December, I wrote:
I’d like to make a couple clarifications. Regarding mechanics, I expect investors to look at their profits (i.e., how much money they’ve made above the initial investment) and then calculate how many shares they need to sell in order to take these profits off the table. Second, if you’re not a “long-term reader,” chances are you probably don’t have profits to take from the specific stock–you’re unaffected by the recommendation. The fact that I haven’t advised selling the stock outright indicates that it remains a good long-term holding.
FALLS CHURCH, Va.–Sentiment in global markets remains basically unchanged: It’s a fairly bullish attitude built on expectations for a relatively smooth slowdown in the global economy and, consequently, solid performance for the financial markets. There’s also a secondary view, expressed here previously, that markets will experience more volatility in 2007.
I’ve outlined my perspectives on these issues (see SRI, 10 January 2007, Fiddler On The Roof, SRI, 27 December 2006, SRI, Abridged II and SRI, 13 December 2006, Pushing The Envelope) and won’t repeat them here.
I base strategic decisions on long-held views about economic change; investment recommendations are made according to a particular company’s ability to benefit from these changes. The world economy is going through a transformation, the outcome of which will be a shift in growth leadership. Leadership will be assumed in due course by the East; the process won’t be smooth, but it’s irreversible. The new, rising economic powers will challenge US supremacy, and although the US will remain a very important player in the global economic stage, it will gradually lose its status as the world’s economic hegemon.
A combination of new developments–the rise of China and India, the re-emergence of Russia and the revival of the Japanese economy–are the main catalysts for this new global economic order. Investing in these changes will offer superior results to the patient, well-positioned investor.
A look at the emerging market economies around the world shows not only that these “21st century nations” have experienced strong growth during the past 10 years but that, since the Asian crisis of 1997, Asia’s performance in particular has been stellar and its economies are on a much stronger footing. Ten years ago, these economies had current account deficits; now the majority of them have current account surpluses.
Their share of the global economy has grown from 31 percent in the early 1990s to 38 percent today. Given that their economic transformation is still in the early stages–after all, China’s urbanization ratio is about where Japan’s was pre-World War II–expect these numbers to continue to improve over time.
It’s imperative that you understand and appreciate this dynamic if you’re to make the most of this gigantic shift in the global economy.
Asia is of particular interest because it’s expected to lead economic transformation and growth for years to come. Asia ex-Japan is currently in a long-term bull market that commenced at the bottom of the Asian crisis in 1998 (see the chart below).
Source: Bloomberg
India
India is by far the most exciting growth story among global emerging markets in general and Asia in particular, one I identified as early as 2001.
Although India has never exhibited the same strong growth characteristics as the rest of Asia and can’t match China’s reported growth rates, it’s also avoided the boom-and-bust cycles so prevalent in the region’s developing economies. For an investor interested in achieving serious long-term returns, this fact is of paramount importance.
And because India still represents only 2 percent of global GDP and 1 percent of world trade, it’s been less important to investors, even after accounting for the strong interest shown by investors since 2004. For more on India, see SRI, 25 October 2006, A Genuine Growth Story.
The Indian market has become quite expensive, and it would come as no surprise to see some profit-taking in the near future; I advised long-term readers to take some money off the table at the end of December.
India remains the best long-term story in Asia, short- and medium-term setbacks notwithstanding. Maintain exposure to India, primarily through Dr. Reddy’s Labs and ICICI Bank.
Japan
Japan–enjoying a secular bull market that commenced in 2003–is another investment theme that should develop into one of the biggest surprises of the decade.
As I’ve noted on numerous occasions, I expect growth to continue as the Japanese economy gradually moves out of deflation while consumers return in strength, thus allowing Japanese firms more pricing power. For more on Japan, please see SRI, 14 June 2006, Complications, SRI, 9 August 2006, Look Out Below and SRI, 18 October 2006, Working For Abe.
Recent developments on the monetary front do, however, bear watching. The decision by the Bank of Japan (BoJ) to leave rates unchanged gave an indication to the market that BoJ members are uncertain about the strength of Japan’s growth. More important, though, there’s substantial evidence that the rate decision was influenced heavily by the government because of upper house elections to be held this summer. If true, the BoJ’s reputation as an independent institution would be damaged.
It remains to be seen if Japanese authorities will be able to effectively navigate the economy back to normality (i.e., out of the deflation trap) and allow it to flourish once again. In the meantime, profits and sales continue to grow for Japanese corporations, in the process beating market participants’ expectations.
Taking a look at the narrower stock market picture, it’s obvious that investors have little interest in Japanese stocks. This is in stark contrast to the beginning of 2006, when people–influenced by the strong rally in the second half of 2005–couldn’t get enough of Japan. I’m still positive on the Japanese story, and the market seems to be a good buy given the negative sentiment surrounding it.
I expect to gradually increase exposure to Japan as the year unfolds. Mitsubishi UFJ Financial Group and Mitsubishi Heavy Industries are my current favorites.
Alternative Holdings recommendation Sumitomo Mitsui Financial Group is another way to play Japan.
The banks offer exposure to the domestic economic growth story, while Mitsubishi Heavy is a play on global industrial growth as well as Japan’s effort to re-establish its military capabilities (see Geopolitics & Investing, 8 February 2006, The Dragon And The Eunuch).
Russia
Russia, another long-time favorite, is currently in the sweet spot: It’s a net oil exporter, has good GDP growth, isn’t dependent on foreign capital flows, is relatively stable politically, has reasonable market valuations and, above all, enjoys solid exposure to the biggest growth story of our time, Asia. For more on Russia, see SRI 19 July 2006, My Friend, The President Of The United States, George W. Bush and SRI, 22 November 2006, SRI, Abridged.
Because oil and gas stocks represent 75 percent of the local market, the price of oil is the key for Russia’s performance this year. Although the economy could withstand (and would actually grow comfortably) oil prices at around USD40, it’s obvious that the market as a whole would suffer.
If the per-barrel price slips below USD40, the Russian market will decline. The decline will be more substantial–on the order of 30 percent–the closer to USD30 the oil price goes. And the opposite is true: If the price of oil remains at current levels, the market will be solid. A strong oil price–above USD60–would lead to gains in the Russian market near 70 percent or so.
My base assumption is that oil won’t trade below USD40 this year and that under the right circumstances an average price of USD50 for 2007 is reasonable. The Portfolio includes exposure to Russian energy plays because energy is in a long-term bull market. And Russia remains the only politically stable, serious energy supplier in the world today.
But Russian growth in 2007 will be driven by domestic investment and consumption. Portfolio holding Vimpel Communications is a play on this theme.
Russian politics will be the wild card this year. Russia will hold parliamentary elections next December, a warm-up to the presidential elections to be held by March 2008. Expect President Putin’s party to win the elections, opening the way for his appointed successor to eventually ascend to the presidency.
On the surface this sounds like a Goldilocks scenario. The reality is that the political struggle will be of monumental proportions as the stakes are extremely high. There will be volatility in 2007–political as well as market-related. Those who are able to see through the smoke and concentrate on what really matters for the stock market and the economy will come out on top.
Don’t expect a real crisis to develop; policymakers have been way too prudent, and financial reserves are sufficient to provide Russia with a range of defenses.
Singapore
Singapore has also been one of my main themes in 2006, and it remains so at the beginning of 2007. Although valuations aren’t as cheap anymore, the underlying story remains intact.
Singapore has been on the receiving end of strong foreign direct investment (FDI) dollars, with a lot of this money finding its way to real estate–residences, hotels, malls and offices. The high-end residential area is particularly hot with foreign investors, as they currently account for 60 percent of demand.
This comes as no surprise; in fact, this part of the market should do well in the future, too, as Singapore implements its program for attracting foreign talent to its growing money management industry. This is the main reason prime office rents are rising rapidly in Singapore. In addition, because the government is repositioning Singapore as a “global city” where one can live, work or just have a good time, a lot of rich people are being persuaded by their money managers to buy luxury property in the country. As a result, new luxury buildings are popping up, and the price per square foot has surpassed, in some cases, USD2,000.
Singapore’s effort to position itself as a banking, convention and entertainment hub in Asia is a multi-year undertaking, but observers expect it to succeed. The government has initiated several projects that will result in more than SGD15 billion (USD9.8 billion) in investment in the tourism sector during the next five years.
The Portfolio includes Singapore exposure mainly through United Overseas Bank, Keppel Corp and City Developments. All have performed well, turning in 30 percent gains on average.
I recently introduced two additional themes, infrastructure (see SRI, 17 January 2007, Buying Infrastructure) and Chinese domestic consumption (see SRI, 24 January 2007, Just Fine). Infrastructure-related companies in the Portfolio include Cheung Kong, Keppel, Mitsubishi Heavy Industries, Datang International Power, ABB and Ericsson. The domestic consumption play is Hengan International.
Portfolio Issues
The SRI Portfolio has been constructed around the view that domestic economic demand and investment are driving Asia’s economic ascent. The areas I’m looking at for investment ideas continue to be property, infrastructure, financials, retail, telecom and utilities.
I#ve noted repeatedly that the Portfolio should be viewed as a whole rather than an assortment of stocks. It’s my hard-earned assumption that investors seldom follow such advice, so I occasionally offer some direction in an effort to assist with the decision-making process.
Currently, it’s obvious that Korea, Taiwan and Japan were the laggards for 2006. Investors who like the “beaten down, not beaten up” approach could play this angle. On the other hand, India, Singapore and Russia have done quite well and should be bought on the basis of the longer-term story.
That said, Portfolio recommendations should be taken at face value, in the sense that, if a stock is recommended as a buy and trades below the price indicated in the Portfolio tables, then the recommendation stands for new readers as well as longer-term ones.
Occasionally, I recommend–as I did quite often toward the end of 2006 and the beginning of 2007–that long-term readers take profits off the table. In December, I wrote:
I also advise long-term readers to take profits from ICICI Bank and Dr. Reddy’s Laboratories–without selling the stocks outright. Take any gains you have and leave the initial capital invested.
I’d like to make a couple clarifications. Regarding mechanics, I expect investors to look at their profits (i.e., how much money they’ve made above the initial investment) and then calculate how many shares they need to sell in order to take these profits off the table. Second, if you’re not a “long-term reader,” chances are you probably don’t have profits to take from the specific stock–you’re unaffected by the recommendation. The fact that I haven’t advised selling the stock outright indicates that it remains a good long-term holding.