FALLS CHURCH, Va.–Asked if Russia would ever join NATO, President Medvedev replied, “Never say never.” This provided a humorous interlude to what was a decidedly staid G-20 meeting, but it bears noting that Madeleine Albright, the US President Elect’s representative, also made positive comments about an unthawing of relations between the two powers.

Whether realistic or not, such a move would allow world leaders to concentrate on addressing pressing economic concerns of the day rather than pursuing foreign policy games.

President Medvedev’s jest comes at a time when the seemingly unthinkable has become reality and forced its way to the forefront of the global consciousness, shocking investors and leaving many long-held tenets in tattered disarray.

Not long ago investors had few qualms about paying 30 times earnings for almost any company; the dot-com frenzy was in full swing, and prevailing sentiment suggested that the new technology boom would allow companies to enjoy endless years of strong earnings growth.

Times have changed, and fundamentals are out the window. Now no one is willing to pay anything for strong companies at discounted prices because all are certain that this is the recession that will prove to be like no other. In other words, we have a natural tendency to emphasize and exaggerate the primacy of our current circumstances; the present almost always seems more powerful and more significant than anything that occurred the past.

Yet investors who lived through the 1974 or 1982 recessions will tell you things were as scary then as now, even without the added wrinkle of complex structured finance products.

And we had similar problems in 1991. The S&L crisis loomed large over the financial services landscape, pumped up by the commercial real estate disaster and the weakness in home prices. Add in the huge banking losses from Latin America loans, mass layoffs on Wall Street, unemployment in the manufacturing sector as well as an overleveraged consumer and government–and suddenly it’s back to the future.

We continue to maintain that the global economy will not lapse into depression (see Silk, 24 September 2008, A New Economic Era), though it appears that the market remains extremely oversold and stretched on the downside. That being said, we could very easily be wrong; in that event, the depression scenario will be the reality, and the market would have been right in trying to discount it.

As the competition for the most negative, sensationalist headline is still on, investors will stay away from growth for some time, allowing prudent bargain hunters to position themselves for the next cycle.

Still, investors should ensure that their portfolios are well hedged, with a core group of financially strong, non-cyclical holdings. Hedging in particular has been a priority for The Silk Road Investor since day one, and we continue to recommend the strategy. There will be a time for a more aggressive approach–potentially during the first quarter of next year. 

Note that the Portfolio has a clear preference for financials and telecommunication companies. We rate the former because they should be the sole benefactors of falling interest rates, while offering great exposure to Asia’s long-term domestic demand investment theme.

Our telecom selections offer exposure strong cash flows, sustainable dividends and growth potential. Use the Fresh Money Buys list for as a guideline for fund allocation.

There have been a lot of headlines as of late regarding the sovereign risks of emerging market economies. Although many emerging economies will pay the price for irresponsibility, it’s truly perplexing when the press keeps pushing the idea that prudent fiscal policy followers will also suffer the same fate.

Russia is a clear case in point: Prevailing sentiment suggests that because of its market carnage and the failure of a couple of oligarchs, the state’s foreign exchange reserves will not be enough to cushion the economy.

The proof, the logic goes, is that Russia’s foreign reserves have dropped USD123 billion from their highs in August to USD475.4 billion, marking the beginning of the end for the Russian economy.

The 20 percent-plus drop is unquestionably substantial, but by no means is out of the ordinary, nor is it inflicting as much long-term damage as the bleak headlines suggest.

Russian foreign reserves break down as follows: approximately 47 percent USD; 42 percent EUR; 10 percent GBP; and 1 percent Yen. As a result, the US dollar’s rally has caused a big part of the allocation to decrease in value; foreign reserves are reported in USD no matter what the actual holdings are. It’s estimated that USD51 billion of the decline is due to valuation losses.

Second, Russia has sizable reserves outside of its official reserves in its national Wealth Fund and its Reserve Fund– something can’t be said about other emerging economies. The latter has USD134.6 in its coffers, while the wealth fund has USD62.82 billion. The wealth fund actually saw an increase last month from USD48.68 billion.

I’ve long emphasized the importance of foreign exchange reserves for the emerging economies; these funds help economies weather the rough times.

Now is the time that these funds will be used. When the biggest economy in the world faces with countless economic and solvency issues, efforts to divert attention from its plight by pointing fingers at Russia’s massive infusions of its own cash into the economy are somewhat comical.

The Russian economy does have its problems and challenges, and there are things they could have done differently in the early stages of the crisis, especially with regard to the stock market. I’ll revisit these issues in an upcoming report, but until then keep in mind that the last problem one has to worry in Russia is one of economic sovereignty. 

Given the size of its borrowings and financial standing, it should come as no surprise if creditors request higher interest rates. At that time the anodyne of easy credit at low rates will become a thing of the past, and interest payments will increase substantially–around USD70 billion at current prices per year for an extra 1 percent rise in interest rates.

At this point, the USD stops being the reserve currency of the world and remains the de facto medium of exchange. Currently the biggest holder of US Treasuries is China, with USD 585 billion worth of paper; Japan runs a close second at USD573.2 billion.

The point is that holistic change doesn’t occur at a selective level. As a result, I still expect that Asia will lead the new economic era for the simple reason that this is the region with substantial savings and dynamic growth potential.

Asia cannot and will not save the world, but it will be able to survive the turmoil and become the first economic region out of the gates once the global economy starts functioning again.

As I mentioned last week, China’s economic stimulus package has been the most positive news item for sometime because the government has finally acted in a synchronized way to make sure the economy will be cushioned on the downside. It’s therefore good to see that loan growth ticked up in China to 14.6 percent to USD27 billion for the month of October.

China remains the best positioned economy in this scary environment, and its stock market does offers opportunities at these levels.

Chunghwa Telecom (NYSE: CHT) is being added to the Silk Portfolio, as it offers great value at current levels combined with a 7 percent sustainable yield.

Chunghwa is the leading integrated telecom service provider in Taiwan. With 12.9 million lines in service it’s the largest fixed-line provider in Taiwan and has over 95 percent market share. The company has a 41 percent wireless subscriber market share and over 80 percent for broadband. The company’s privatization was completed in August 2005, when the Ministry of Transportation and Communication–its largest shareholder–reduced its stake below 50 percent. 

The company provides stable stream of dividends and earnings from its core operations. Furthermore, its large capital surplus also allows for return of excess cash to stockholders in regular intervals. Buy Chunghwa Telecom at current prices.

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.

• China (machinery, Consumer, Insurance, Banks, port, coal, e-commerce)
• Hong Kong (real estate, banking)
• Russia (energy, telecommunications)
• India (pharmaceuticals)
• Taiwan (telecommunications, ETF)
• Philippines (telecommunications)
• Japan (banking)
• Indonesia (Telecom)
• Singapore (Industrial)
• Vietnam (ETF)
• Cambodia (casino/hotels)
• Macau (casino/hotels)