SRI, Abridged

Editor’s Note: A weekly publication, SRI doesn’t take any breaks. That said, it seems to me that long holiday weekends like Thanksgiving and New Year#s offer opportunities for some thinking and reflecting, which I plan to do. Consequently, issues that fall during holiday weekends are a bit shorter than normal, with more scattered thoughts than usual.

Happy Thanksgiving.


By Yiannis G. Mostrous

FALLS CHURCH, Va.–I recently attended a party hosted by a very wealthy individual, a friend of a friend. There I found myself in the company of a couple US-based fund managers who work for some of the biggest financial institutions in this country. The conversation inevitably drifted toward the markets.

Their assessment was that the US would be the best-performing market in the world in 2007. The US economy will land softly, they reasoned, and consequently grow at a satisfactory rate, encountering no major problems on the inflation and interest rate fronts.

I had no problem accepting their point of view, especially the second part. But I couldn’t help but point out that Asia should do as well as, if not better than, the US under an economic scenario like the one they described. Oddly enough, they were adamant that this can’t happen “because Asia has performed well for some time and now is the US’ time to catch up.”

That last statement shocked me. It’s well known that the major problem the Asian markets could face next year is a hard economic landing in the US and, most important, an abysmal US market performance. However, if the US does pretty well, there’s no reason why Asia can’t do at least as well–given that the major worry will be no more.

Encounters like this offer credence to the idea that, although many investors may be invested in Asia, comparatively, few are able or willing to understand the important changes taking place in the region. And in the long term, this favors the knowledgeable investor, or more important, the one who is willing to contemplate change and its consequences.

As it’s a little early to start positioning for 2007, the fact of the matter is that the books are closing for 2006. But because the SRI Portfolio has significant exposure to Asia, it pays to wait for the usually strong seasonal time for Asian equities–November to February–to see if the gods of the markets will be good to us. Sometimes they are.

Russia

The big Russian bear has long been a favorite of mine, and it remains so. In three weeks, I’ll be meeting with some investment managers who are active there, but a word is due on the subject, given the recent signing of bilateral terms with the US on Russia’s entry into the World Trade Organization (WTO).

As I noted during the summer (see SRI, 19 July 2006, My Friend, The President Of The United States, George W. Bush):
President Putin may have employed his now-famous wit to describe at least the US posture toward his country when he referred to his counterpart during a joint press conference as, “My friend, the President of the United States, George W. Bush.”

Look no further than the joint US/Russia announcement of a deal to cooperate on civil nuclear programs. The statement addressed, among other things, the creation of “a system of international centers to provide nuclear fuel services, including uranium enrichment, under IAEA (International Atomic Energy Agency) safeguards.” President Putin said the idea was to create a system giving all states access to nuclear power while guarding against the proliferation of nuclear weapons. The first center would be in Eastern Siberia.

It goes without saying that it will take time for such a deal to come through. But note that this is a groundbreaking idea. If successful, such a system would bring the US and Russia closer together and could help defuse some of the world’s problems.

And the two countries are gradually coming closer together. Bush and Putin have been much more politically astute than the irritable and usually irresponsible condemning voices in both countries gave them credit for.

That said, the Washington, DC establishment is becoming more open to the idea that Russia’s involvement in the global economy is in America’s best interest. Congress, therefore, will probably not try to stop the process.

Overall, WTO entrance is a positive for Russia. The country will now be able to participate more freely in foreign markets, especially in industries in which it has some expertise–for example, steel, fertilizer and petrochemicals. On the other hand, Russia’s two main industries–energy and weapons–won’t be affected by the new agreement.

The country’s legendary corrupt bureaucracy notwithstanding, its participation in global organizations like the WTO should work as Russia tries to bring its laws and institutions in line with global practices.

I remain committed to Russia and expect its economy and market to provide healthy returns to patient investors. Russia should continue to benefit from the fact that energy is still in a secular bull market. If its leadership carries on and enhances the positive changes brought about during the Putin presidency, Russia could surprise to the upside.

Speaking of energy, I wrote almost two years ago in another advisory that oil has established a new base of USD40 per barrel. Although that’s quite a bit lower than where oil’s trading today, the point to understand is that secular bull markets take time to develop. Two years ago, everyone was talking about USD25 oil, but today USD40 would be seen as manna from heaven.

And in the short term that might be so. But from a long-term (read: secular) perspective, the fact of the matter is that the next leg up for oil will be from the elevated level of USD40. The base-case scenario will, in time, increase once again from USD40 to maybe USD50, and so on. This is how bull markets develop.

Tactically, though, oil could go to USD40 next year. In that case, the Russian market would have a tough time rising more than 10 percent in 2007.

The two main SRI recommendations for Russia, Gazprom and Lukoil, are geared for higher energy prices (Gazprom moreso than Lukoil). There’s considerable upside for both if energy prices remain elevated, though investors should be prepared for declines if they don’t.

The other two recommendations, Vimpel Comm and Wimm Foods, are plays on the domestic economic growth. Given their recent performances (up 60 percent and 23 percent, respectively), both could potentially be sold to take some profits.

Fresh Money Buys

I’ve noted repeatedly that the SRI 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 are 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.

Europe remains a big favorite; it will outperform the US in 2007 just as it did in 2006. SRI Portfolio recommendations offer value (Sanofi and Mediaset), long-term growth (Ericsson, Allianz, ASML and Danone) and a turnaround story (ABN Amro). Longer-term readers should just follow the advice as it’s offered; I assume that some of you are already invested in some of the recommended stocks (and that you’re well diversified).

Technical Issues

SRI has one main portfolio, the Long-Term Portfolio, and an alternative portfolio, Alternative Holdings-Permanent Hedges. Investors should look first to the Long-Term Portfolio for asset allocation in the markets covered here.

In the Alternative Holdings-Permanent Hedges Portfolio, readers can track permanent hedges and shorter-term recommendations. It also includes companies I’ve recommended but haven’t added to the Long-Term Portfolio; for example, Lukoil provides extra exposure to a favored theme.

A new feature has been added to the Web site. On the left-hand side of the screen, under the title “Portfolio Performance,” readers can get a snapshot of the SRI Portfolio’s return versus other major indexes. You’ll also find an explanation of the way I view the investment process. (This is especially helpful to new readers.)

On the Portfolio page, you can click on the asterisk next to each holding to review the original commentary and recommendation. We plan to enhance the Portfolio table with extra features as soon as our IT guys give us the OK.

Many readers have requested information on brokers that can better execute SRI recommendations. Click the headline “Resources” and see “Brokers & Services.”

E*Trade is a mainstream broker that can now handle some international trading online. Commissions are slightly higher, but the Web site is particularly easy to use and includes solid news and quote feeds for most foreign markets.

According to a recent Wall Street Journal article, Fidelity has seen a fourfold increase in customer requests for international stock purchases. As a result, it’s beefed up its customer service staff to handle the transactions. You can buy foreign stocks through Fidelity by calling the broker directly.

If you’ve had positive experiences buying foreign stocks with other brokers, please drop me an e-mail and I’ll include them in an upcoming issue. And if you plan on getting into some of my non-US traded stocks, be sure to check out your current broker’s capabilities.