A Sunny Afternoon

By Yiannis G. Mostrous

ATHENS, GREECE–Silk Road Investor comes to you this week from Greece, somewhat removed from the action but close enough to observe that the market’s mood is still good and that investors don’t seem in any particular hurry to liquidate positions.

The Portfolio remains unchanged, though I’m looking for a new European play as a means of taking advantage of a trend I’ve seen in my current travels. I’ll have more on this story next week.

The idea for this week’s issue sprang from a recent meeting with an old friend. He works for a US-based logistics company, as a director for Europe and the Middle East. Business has been booming, and he was recently asked to join some of his colleagues from other regions on a trip to witness the progress the company has made expanding in Asia, especially India and China.

He talked enthusiastically not only about his personal views regarding Asia’s economic growth, but also–and more significant to him personally–about how this transformation has been extremely beneficial to his company (globalization and economic change analyzed in a downtown Athens cafe during a leisurely sunny afternoon under the Parthenon: What would the gods have thought?).

Globalization isn’t a new phenomenon–it’s a constant rooted in the power free trade bestows upon participants. Globalization (though not labeled as such) has existed throughout the centuries; economic historians consider the period from 1865 to 1914 to be the golden age of globalization. This was a relatively peaceful period (especially in light of the era that followed) marked by declining tariffs and transportation costs, the latter due to steamships, railroads, the Suez Canal, coupled with the great human migrations and increased capital flows.

China’s and India’s participation in this latest version is a rather unique element–the two Asian powers together hold potential unparalleled by other emerging economies in prior periods of globalization. Although many observers expected these two countries would eventually demand more from the global economic pie, the actual fact of its occurrence has taken the majority by surprise. Hence, investors were generally late to jump on the trend.

On the other hand, corporations have fared a little better. Some were lucky–or skillful–enough to identify the trend and invest appropriately. One example is the growth in the percentage of manufacturing workers employed by US subsidiaries in China: From just 3 percent of the total in 1990 to a solid 30 percent by 1999.

Given that most SRI readers are US based and own stocks of quite a few US corporations, the idea that grew out of the conversation with my old friend was to identify the Asian exposure of various big US companies; because of SRI’s positive view on Europe, we’ll also take a look at US participation in that market. Asia is, of course, the high-growth market, so for long-term structural growth it’s the place to be.

Note that the Portfolio holds no US companies–SRI looks to the rest of the world for opportunities. The companies presented here today won’t be included in the Portfolio, but you’ll hopefully emerge with an understanding of the extent to which US corporations are taking advantage of changes in the global economy.

As discussed in the inaugural issue (see SRI, 15 February 2006, The Rules Of Engagement):
The premise of this advisory is economic change. The idea here is that the world is moving to a more multipolar system and this shift is having a great effect on the global economy, as new economic superpowers rise and prepare to challenge US supremacy. Although the US will remain a very important player in the global economic stage, it will gradually lose its title as 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.

Understanding the forces of globalization would have allowed investors to better recognize and act upon certain changes in the world economy. Higher energy and commodity prices are obvious examples. But few–excluding the oil permabulls–spoke positively or invested in the oil sector in 2002-03, for example.

Globalization is changing the world, and company thinking must adapt. In the meantime, globalization’s forces are helping companies contain wages and increase productivity and, consequently, profits. In general, globalization has been extremely beneficial to multi-national corporations. The list that follows isn’t exhaustive; the main criterion for inclusion is that sales in Asia currently represent more than 20 percent of total sales.

The Companies

AIG (NYSE: AIG) derives 28 percent of its sales from and is the leading foreign insurer in Asia. The company was actually founded in Shanghai in 1919. In 1992, AIG was given a license to operate life and non-life insurance businesses in China. It currently has around 1 percent of the life insurance market in China.

Citigroup (NYSE: C), with 21 percent of its sales in Asia, is probably the best-positioned US financial firm in the retail sector. Prudential Financial (NYSE: PRU) has 54 percent of its sales in Asia, 40 percent of that total coming from Japan, South Korea and Taiwan.

Technology is one of the biggest US exports to Asia, China in particular. Semiconductors are the most exposed. Intel (NSDQ: INTC, 54 percent of sales), Texas Instruments (NYSE: TXN, 62 percent) and Applied Materials (NSDQ: AMAT, 73 percent) dominate. Given that these three companies supply a lot of components to the growing Asian technology supply chain, the current figures don’t reflect Asian end-user demand solely, but rather global demand.

Coca-Cola (NYSE: KO) draws 22 percent of its sales in Asia, which also represents one of its top five markets in terms of volume globally.

3M (NYSE: MMM), with 26 percent of sales, is also well positioned.

There are other companies that, although not deriving 20 percent of their sales from Asia, they’re pretty close and, more important, are growing quite fast in the region.

Thermo Electron (NYSE: TMO), a worldwide provider of analytical instruments, scientific equipment, services and software solutions for life science, drug discovery, and clinical, environmental and industrial laboratories, currently draws 17 percent of its sales in Asia.

McDonald’s (NYSE: MCD) and Yum Brands (NYSE: YUM) have seen solid, double-digit investment returns.

Johnson & Johnson (NYSE: JNJ), with its highly diversified product line, is expanding Asian operations rapidly; it currently gets 12 percent of total sales there. The same holds true for Colgate (NYSE: CL), currently with 18 percent in sales.

A Note To Readers

This being a new service, I’ve received many questions about portfolio construction and stock selection. Let me take an opportunity to reiterate an explanation from last week’s issue:

The approach here is top-down. I first identify long-term investment themes (or, as my colleagues and I call them, global secular trends). Because of the long-term approach, the Portfolio must be able to endure short-term volatility as long as we continue to be on the correct side of the global secular trend. To achieve this, the Portfolio is being constructed to offer a diversified set of holdings, while I also offer hedging ideas for more complete advice.

A characteristic common to the Portfolio companies is suitabilitiy for the new realities of a changing world. They’ll benefit the most from the changes taking place in the global economy.

That said, no one knows how long it will take for the global economy to navigate the secular trend identified here. This is the reason investors need to remain focused and have a portfolio that can last and perform well on a tactical basis. After all, the way to stay in the game is by not losing all the money, and tactical mistakes can cause that. This is the main reason I won’t put convictions above analysis and will avoid suggesting only one type of attitude or trade, especially short-only strategies.

It’s important that you look at the Portfolio as a whole and not as an assortment of stock tips. Although few people will buy the Portfolio in its entirety, you, at the very least, need to buy SRI’s investment theme in order to diversify. Buying only banks or tech companies because you like the stories might offer a reward, but such an approach won’t provide the lasting benefits of the overall Portfolio.

Keep in mind that SRI comes to you weekly and always offers current advice. Adding and subtracting stocks from the Portfolio can be done easier this way. There’s always another week and neither readers nor the editor need to rush. Patience has always been a good thing to have when investing.