Nevertheless, caution is warranted. The subprime crisis has turned into an assault on the world’s credit structure, but the synchronized efforts of central banks will keep the system alive. The markets aren’t powerful enough or willing to fight the central banks of the world, especially when they act in concert.

This doesn’t mean the global economy won’t slow or the US will avoid a recession of some sort. All it means is the world’s financial system won’t collapse.

For the Silk universe, however, things are a bit more complicated. Our markets finished their fifth year of absolute performance dominance versus the rest of the world. For that reason, this year may require a little more agility than 2007.”

The foregoing commentary is from January (see Silk, 2 January 2008, The Year of the Rat), and the scenario described is playing out as expected. For this reason, the newly converted bears who exclaim that the world’s economy and markets are going to hell make no impression on me.

It’s well known that the world’s financial system won’t collapse, although a lot of profound changes will take place as structured finance disappears. It’s also clear that the checks and balances of the US-centric financial system didn’t work, at least not as well as the majority had hoped.

The next surprise will come from the fact that the major emerging market economies will be able to weather the storm much better than before, while also lending a hand to the ailing financial institutions of the developed world. On the other hand, finance-based economies (i.e., the UK) will be faced with great danger as the so-called London Miracle gradually comes to a close.  

I expect Japan to continue to outperform the majority of developed markets because the negatives are already priced in. Add the great potential for an economy that’s trying to break out of a chronic deflationary disaster and you have a strong, short-term and long-term bet.

I still prefer financials and insurance companies in Japan. Silk Portfolio recommendations in this sector are Mitsubishi UFJ Financial (Japan: 8306, NYSE: MTU) and T&D Holdings (Japan: 8795, OTC: TDHOF).

Expect the major emerging markets (i.e., China, Russia, India, the Gulf States and Brazil) to experience slower growth but not recession this year and to bounce back stronger when economic conditions improve.

For Asia in particular, which is the engine driving the strong global economic growth we’ve enjoyed over the last two years, the picture remains bright. See Silk, 27 February 2008, A Year of Consolidation.

Despite the short-term challenges Asian economies face–particularly high inflation–they’ve already entered the early stages of a cycle of capital investment, infrastructure spending and domestic consumption.

The latter remains the main reason for investing in the region because the current economic turmoil drives the point home. These economies can’t move decisively forward through the vendor financing approach in which companies lend money to their own clients in order to buy their products, as the dot-com companies did in the 1990s.   

China, India, and Russia are the three main economies able to lead the way in structural changes that will continue to enhance domestic demand growth. It’s going to be a slow process, but it’s already underway.

Shorter-term pessimism reigns, and I expect volatility to continue to play a great role this year. Asia is reaching bargain prices, especially for investors who are willing to see beyond the next two or three quarters.

When I talk about the long term, it’s not just a euphemism designed to entice you to buy stocks. If an investor is allocating funds over the long term, these are the best places to put money to work, and you’ll have to wait for the global turmoil to subside for the investments to bear fruit.

The opportunity to purchase strong assets at a discount presents itself when circumstances are bleak, especially when growth prospects are robust, as is the case in Asia. 

I still expect the US to experience even slower growth and the American consumer to slow down dramatically as unemployment rises and the credit disaster reaches higher into the economic strata. This is why our long-term portfolio hedge to short the American consumer through the Consumer Discretionary SPDR (AMEX: XLY) will be retained. This is a natural hedge for a long-only emerging market/Asia-led portfolio, as is the HSBC Holdings (NYSE: HBC) short.

The latter remains the biggest camouflaged financial in the world since investors focus a lot of attention on the bank’s exposure to Asia, while disregarding the fact that HSBC’s bread and butter is, by far, the American and British consumer.

Using the Fresh Money Buys

Long-term readers should be familiar with the Fresh Money Buys found at the end of every Silk issue.

It’s an attempt to organize the portfolio recommendations in a descending order based on return and risk characteristics as well as my best assessment on what an investor should buy first if allocation of fresh capital is the issue. The order changes at least once a month as I try to assess which market will perform better so I can give you a solid start.

This month, China moves up to the fifth spot on the list; the market should be able to perform well as valuations have become much more reasonable following relentless selling of late.

If you’d like to buy five stocks from the Silk portfolio, follow the selection below.

First is the Russian energy giant Gazprom (OTC: OGZPY), which is one of the best bets on the long-term energy boom given its reserves, its dominant position in the European market and its increasingly strong positioning in emerging economies.

Bank of China Hong Kong (Hong Kong: 2388, OTC: BHKLY, BoCHK) is my favorite play in Hong Kong, which is currently Silk’s second-best market. The stock trades at attractive valuations and will continue to benefit from the economy’s growth, especially as real estate remains healthy in Hong Kong.

On the latter issue, real estate stocks in Hong Kong are discounting a lot of bad news. My assessment is that the companies will surprise on the upside earnings wise, and stock prices will rise. As a result, gain some exposure to the sector through portfolio holding Cheung Kong (Hong Kong: 1, OTC: CHEUY). For more on Hong Kong real estate, see Silk, 28 May 2008, Real Estate in Hong Kong.

My favorite stock in India is the pharmaceutical Dr. Reddys Laboratories (India: DRRD, NYSE: RDY). We’ve had a lot of profitable trades in India, and I still think this is one of the best long-term growth stories in the emerging-market world. I expect Dr. Reddys will benefit from the currency depreciation, while valuations are undemanding as investors have been chasing higher-growth stocks. 

We got out a little early late last year, but the market hasn’t performed very well. In retrospect, it was a decent decision. I always look for some encouraging signs to re-enter the market with more conviction as short-term turbulence can be substantial. The market has become a short-term voting mechanism for investors who have been selling quite aggressively.

As I mentioned earlier, I expect Japan to outperform developed markets. Its longer-term kicker is its ability to conquer its deflationary years. As a result, I favor Japanese financials. See Silk, 4 June 2008, Summer Rally, for more on the Japanese investment story.

My fifth favorite market is China. The first Chinese stock investors should buy is diaper producer and long-term Silk favorite Hengan International (Hong Kong: 1044, OTC: HEGIF). I call this stock defensive growth because it offers strong long-term growth in a relatively new sector of Chinese consumption while demand remains quite inelastic. See Silk, 13 February 2008, Increasingly Stronger. 

Finally, the frontier markets of Cambodia and Vietnam are long-term favorites. But given their small size, these inherently risky picks are featured at the bottom of the list. These are markets in which individual investors can allocate capital, recognizing that the reward can be substantial but understanding that they also carry plenty of risk. See Silk, 5 March 2008, Holiday in Cambodia.

Russian Expansion

One of my favorite Russian telecom companies, VimpelCom (NYSE: VIP), is expanding in two of the most promising frontier economies in the world: Cambodia and Vietnam.

According to recent news, VimpelCom is moving ahead with the acquisition of Cambodian Sotelco for USD28 million. Sotelco has national Global Systems for Mobile (GSM) communications–which uses 900 MHz and 1800 MHz bands–IP-telephony and WiMax licenses and plans to launch its operations. VimpelCom will own 90 percent of the venture, and a local company will hold the remaining 10 percent. This is a great long-term opportunity for VimpelCom as mobile penetration in the country is below 20 percent, while GDP growth is close to 10 percent.

In Vietnam, the company plans to spend USD267 million to form a joint venture–GTEL-Mobile–in which VimpelCom will hold a 40 percent stake. A state-run Vietnamese company will own the remaining 60 percent. 

Obviously, both investments should be viewed as long-term plays; they’re indicative of where growth can be found for years to come. VimpelCom remains a buy.

The Short Trade

Six weeks ago, I recommended shorting HSBC Holdings (NYSE: HBC). See Silk, 14 May 2008, The Long and Short of It. The main argument for the trade is that HSBC holds 63 percent of its loans in the US and the UK, and its stock hasn’t suffered nearly as much as the rest of the global banks. The trade has produced a 15 percent gain since recommendation.

I still expect it to be hit harder in the downturn, and it’s a good hedge to our long positions. If you’re in the trade, place your stop at USD86. You can also enter the trade now using the same stop/loss of USD86.

Fresh Money Buys

The investment process is constant. 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 Portfolio tables for details.

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