FALLS CHURCH, Va.–The fifth month brings with it the old adage, “Sell in May and go away.” A year ago, I wrote that there was a possibility that May wouldn’t be a negative month for the markets, but the markets had a different opinion and promptly sold off. The only consolation was that I was quick enough to issue a flash alert early into the selloff, which allowed readers enough time to readjust their positions. (See SRI, 15 May 2006, Silk Road Investor-Flash.)

But I also wrote around that time:

The view here remains that a selloff will definitely be harmful to Asian stocks, but the region’s markets–including Japan–will recover nicely and much faster than many observers expect. I’ve offered a rationale for this assessment on many occasions; it’s based on the view that 1998 marked both a bottom for Asian markets and the commencement of a new multiyear bull market. This new bull market is supported by superior Asian growth prospects and the consequent, though gradual, return of local investors to their home stock markets. (See SRI, 15 February 2006, The Rules Of Engagement, and 22 March 2006, Until It Melts.)

In hindsight, that was exactly what happened. And now we’ve reached the point where few investors are actually thinking of a correction.

In regard to Asia, May has traditionally been a weak month, as has June. On the other hand, staying away from the market from May until the end of August hasn’t been very rewarding. During these months, bargains arise and portfolios can be positioned for the traditionally strong periods in Asian markets, namely late September to late January.

Going back a few years, the biggest corrections in the context of Asian markets occurred in May 2005 (down 19.8 percent), April 2005 (down 7.8 percent), October 2005 (down 8.3 percent), May 2006 (down 18.6 percent) and March 2007 (down 10 percent).

Looking at the markets now, there are a couple of things that stand on opposite sides. On the positive, some countries and sectors that traditionally trade at high premiums to the rest aren’t now. The most-important examples are India, which currently has a much lower valuation premium to the rest of the region, and the technology sector, which actually trades at a discount to the other sectors. There may be a good reason for this, but nevertheless, technology does trade at a discount.

On the negative side are the relentless rise in the Chinese domestic shares markets and elevated buying levels by foreign investors. The former (Shanghai) currently trades at 6.3 times price-to-book value with a 10-year average of 3.6 times; the price-to-earnings ratio is quickly approaching the 2001 level of 72 times.

On the latter, foreign buying of Asian stocks surpassed USD7 billion last month–one of the highest amounts on record. If anything, the markets may need some more time to digest such a sum.

That said, a correction can take place at any time, especially if the Chinese government decides that it wants, once again, to cool down its overheated stock market. Timing an event of that sort is a futile exercise, though; the few people I know who’ve repeatedly tried to do it are still nursing their wounds.

One projection that I will risk right now is that if a correction does take place–now or in a couple months–the markets will come out of it quite strong, a global recession notwithstanding. Consequently, investors are advised to confine themselves to quality holdings as we enter the summer season. As always, see the Fresh Money Buys list below for loose guidance regarding allocation.

Malaysia

Last month, I recommended taking profits (without selling stocks outright) from some holdings, including Malaysia. (See SRI, 11 April 2007, Tempering Greed.) The Malaysian market is up 4 percent since then, and it remains one of my favorite markets for this year.

Earnings continue to be strong, and the government is liberalizing economic policies. A lot of this appears to be priced into the market, and a pullback can’t be ruled out.

Such an event, and as things stand now, should be viewed as a buying opportunity. In the context of the SRI recommendations, that means buying the iShares Malaysia.

Fresh Money Buys

If you’d like to add to your positions in Portfolio recommendations or allocate new funds, focus on the following markets, in order (for both countries and sectors): South Korea, Hong Kong (real estate, publishing, infrastructure), India (pharmaceutical, banking), Malaysia, Russia (telecommunications, energy), Singapore (telecommunications, banking, industrial), Europe (pharmaceuticals, oil, industrials, communications equipment, media), Japan (industrials, banking), China (consumer, power, oil), Taiwan (telecommunications, technology) and Macau.

Earnings

Royal Dutch Shell reported good numbers with USD earnings per share up 14 percent year over year. Cash flow was also very strong at USD11,181million, while the exploration and production part of the business was weak.

Shell is a turnaround story–one I’ve been following for a long time. As such, it should be a part of a long-term portfolio, especially if investors agree with my long-held view that oil prices will remain stronger for longer. I also expect the company to resume its share buy-back program, given its strong cash position and low debt levels.

Sanofi-Aventis is the most-underrated pharmaceutical in Europe and will eventually surprise a lot of investors to the upside. The company reported unspectacular numbers, which was expected given the various disappointments with some of its drugs.

But Sanofi can prove the big winner because it has one of the best pipelines in the world among the big pharmaceutical companies, with around 58 new drugs in Phase II and Phase III development. I expect Sanofi to start rolling out late stage clinical trial data in the second half of this year and the first two quarters of 2008. Furthermore, you should expect at least a 30 percent success in these trials and the eventual full re-rating of the company’s shares.

Shinhan Financial is my favorite play for exposure to the improving domestic demand story in South Korea.

As I’ve noted before, I expect the economy to surprise observers with its resilience this year. As the country approaches its December presidential election, it’s widely accepted now that a Grand National Party victory will reverse President Roh’s left-leaning policies. I expect a domestic consumption boom, especially by the well-to-do strata of society, whose wealth Roh sought to limit.

South Korea also has enough room to ease monetary conditions as a means to restart the economy should a slowdown take place. Expect earnings upgrades during the second half of 2007 as analysts begin to realize that things aren’t as bad as initially thought.

Shinhan reported solid numbers with lending growth of 3.6 percent quarter over quarter and strong commission growth of 23 percent quarter over quarter. It also showed solid asset quality with a nonperforming loan ratio of 1.1 percent.

Singapore Telecom reported a profit decline to USD652 million because of weakness in its Indonesian operations. Nevertheless, it remains a core holding of the SRI Long-Term Portfolio because I see it as a low-risk, dividend-paying quality company that offers exposure to the defensive cash flows of mature markets (Singapore and Australia) as well as fast-growing markets.

Singapore Telecom has a presence through minority stakes in other strong companies in India (Bharti), Indonesia (Telkomsel), Thailand (AIS), Bangladesh (Pacific Bangladesh Telecom), and the Philippines (Globe Telecom). It’s announced plans for new investments in Central Asia and the Middle East.

United Overseas Bank’s first quarter earnings grew 18 percent on a year-over-year basis, although the numbers were down 4 percent quarter over quarter. Its weakest link was its Thailand operations, while Singapore and Malaysia operations were quite strong. Mortgage growth in Singapore was also solid.

The company is one of the best proxies to capitalize on the strong growth of the Singaporean economy as it reinvents itself one more time. I’ve explored this theme before, and investors should familiarize themselves with the specifics if they haven’t done so yet. (See SRI 4 October 2006, Portfolio Shuffle, and SRI 11 October 2006, Testing…Testing.)

AU Optronics reported weak earnings as I expected, barely breaking even at the gross profit level. This is a stock that will perform well during a potential improvement in the US economy in the second half of the year. The stock is up a little more than 10 percent since my initial recommendation–not a great number, I agree–but it can do better going forward, especially if the technology sector starts to get some more respect.

Datang International Power, which reported yearly numbers in early April, saw its earnings jump 18 percent year over year. The company is a play in China’s infrastructure–an investment theme I think still has a lot to offer in a China as well as in an Asia/emerging market context. (See SRI, 17 January 2007, Buying Infrastructure.)

Datang is my favorite company in the power sector in China because it’s demonstrated good cost-control practices and an ability to increase margins.

I’ve suggested Italy-based MediaSet as a turnaround play with a good dividend yield. The company hasn’t been able to perform as well as initially expected. It reported weak results mainly because of weakness in the Italian advertising numbers, although Spanish operations did quiet well.

That said, the stock will be still recommended in the Alternative Holdings Portfolio as valuations remain decent while a 5 percent dividend yield is good support.

Note last week I wrote that Keppel Corp split its stock 2-for-1. The reference was to the local shares trading in Singapore. There was some confusion with the American Depository Receipts (ADRs), which didn’t adjust immediately; some readers–after they had been given erroneous information from their brokers–wondered if they should buy or not. The Keppel Corp ADRs have now adjusted and trade at around USD14.50 in the over-the-counter market.