American policymakers are one step closer to nationalizing mortgages. The Federal Reserve’s latest effort to inject liquidity in the interbank market–the loans will be collateralized by the weakest assets–is clear evidence of this trend.

The US central bank will continue to cut rates aggressively in an effort to support a weakening economy. The European Central Bank, the Swiss National Bank and the Bank of Canada have also pledged to boost liquidity.

Markets reacted accordingly, jumping off recent lows. This comes as no surprise; we were due for a rally. Perhaps we’ll even see a prolonged upswing.

The short-term bounce notwithstanding, pessimism reigns supreme. Just last week, a friend told me, “Things are structurally bearish [in London].” Being overly bearish at this juncture seems a little over the top, and perhaps describes those investors who exercised no caution last year.

The risks are high, and the financial system could be brought to its knees. But these aren’t tactical risks per se and, therefore, don’t preclude a rally.

Continue to allocate funds to Silk Portfolio recommendations. Also, put money in the recommended hedges for a more balanced approach.

When I wrote The Silk Road to Riches: How You Can Profit by Investing in Asia’s Newfound Prosperity, I argued that it was necessary for Asia’s leaders to include more and more people in the economic growth process in order to spread the benefits of the region’s wealth creation.

This still holds true, although it will be a long process. However, the ruling elite understands, and when they ignore it, people remind them.

This was the case with Malaysia in the recent election in which the ruling party suffered its biggest ever electoral setback, losing its two-thirds parliamentary majority–which allows for constitution amendment–and five of the country’s 13 states.

The vote was the result of the government’s failure to move decisively against corruption and the increased frustration that the Indian and Chinese minorities hold against the country’s Bumiputera policy, which gives preferential treatment to the ethnic Malay, even in matters of business and economics.

The election results sent the market down severely in a day because investors feared instability. We were lucky because we sold out of Malaysia three days before the election for a 45 percent gain. Although I don’t expect any major disturbances in Malaysia’s political outlook that would derail its economy, it will take some time to clear the air. I’ll look for a re-entry point in the coming months.  

The Chinese, on the other hand, are clearly moving toward improving the less advanced regions of the country. Last year the government spent USD61 billions (14.6 percent of overall central government expenditures) in projects that would help the central and western regions of China to start reducing the income gap between the coastal areas and the inland. This year the budget calls for 16.1 percent of overall spending to be allocated in these regions.

The central government has the financial muscle to do so. And in addition to its reserves, China has also reduced its fiscal deficit to 0.8 percent of GDP and is planning to reduce it to 0.6 percent this year.

The infrastructure plays in the Silk portfolios will benefit from the government’s policies this year. China Infrastructure Machineries (Hong Kong: 3339, OTC: CIMHF), and Hopewell Holdings (Hong Kong: 54, OTC: HOWWY) are direct plays to this theme.

The Chinese leadership has repeatedly said that its primary macro goals for 2008 are making food readily available while addressing the current high levels of food price inflation, sustainable energy supply and global/Chinese financial stability.

China values stability and gradualism, especially in terms of its economy. But in order for China to realize its potential, it must provide for its less fortunate citizens to avoid social unrest and gradually move toward economic development. The ship is too big to turn around quickly.

The same goes for India, although there some of its business leaders have confused the roles of a business leader and that of a Maharaja.

Nevertheless, the government’s last budget has been a positive for Indian farmers. Therefore, the budget allows for debt writeoff for small and marginal farmers worth USD15 billion. After that, farmers are entitled to fresh agricultural loans from banks in accordance with normal rules. About 40 million farmers will benefit from the proposal.

In addition, the budget has announced a number of measures to help the agricultural sector, such as increased allocation for irrigation and other rural infrastructure.

Because India will be having national elections in the next 12 months, the budget also provides steps for managing inflation. The government has decided to cut indirect taxes such as excise duty for select products. It also announced an across reduction in the central value-added tax rate from 16 percent to 14 percent. The government has also reduced the central sales tax from 3 percent to 2 percent effective April 1, 2008.

Finally, in an effort to support consumption, the threshold for tax exempt personal income was increased to USD3,750 from USD2,700 per year.

This week I’m recommending selling Chunghwa Telecom (NYSE: CHT). The stock has been a steady grower for us and has returned 50 percent since I originally added it to the portfolio.

I’m selling Chunghwa because the company has set up a hybrid currency instrument that only benefits when the US dollar is up. It works against the company when the Taiwanese dollar appreciates, which has been the case for sometime now. Even if this works to Chunghwa’s favor in the end, it doesn’t bode well for its stability. Sell Chunghwa Telecom.

During the November market turmoil, I recommended shorting the Chinese insurers for extra protection. (See Silk, 13 November 2007, Flash Alert: Hedging the Portfolios.)

My US trading recommendation was to short China Life Insurance Co (NYSE: LFC). The profit was around 32 percent as of March 11, 2008. If you’ve shorted China Life Insurance Co, stay with the position, and set your stop-loss at USD65. This is a hedging trade for a long-only portfolio, which is why the stop-loss is fairly loose.

I recommended another short last week: HSBC Holdings (Hong Kong: 5, NYSE: HBC). The rational there is simple: It hasn’t been hit as much, although 63 percent of its loans are in the US and UK.

This recommendation should also be viewed as a hedge against a long portfolio because it’s not intended as a stand alone trade. If you have entered the trade, stay with it and place your stop at USD85.

The investment process is constant. So if you’d like to add to your positions in portfolio recommendations or allocate new funds in a diversified way, focus on the following markets, in order (for both countries and sectors). Consult the portfolios on the left-hand side of your screen for details.

• Russia (energy, telecommunications)
• Hong Kong (banking, real estate, infrastructure)
• South Korea (banking)
• Philippines (telecommunications, real estate)
• India (pharmaceuticals)
• China (consumer, telecommunications, machinery, coal, e-commerce, oil)
• Taiwan (ETF)
• Singapore (banking, telecommunications, industrial)
• Japan (banking, industrials)
• Cambodia (casino/hotels)
• Macau (casino/hotels)
• Europe (communications equipment)