FALLS CHURCH, Va.–Global markets show signs of a desire to go higher, but at the same time risks linger. Thus, buying decisions for fund managers are much tougher, and this is how it should be, if only because of the fact that the world’s stock markets haven’t acted healthy when faced with real danger.

The relatively harmless inflation problem led to the May/June 2006 selloff, which so far dwarves the depth and length of the current correction. A healthy response to current conditions would include a similarly deep and lasting correction. The problem now—the US subprime meltdown–could infect the rest of the economy in epic proportions. The US credit system–as well as global financial stability–could be vulnerable, at least in the short term.

As credit problems in the US housing market begin to reach beyond the subprime sector into the wonderful world of adjustable-rate debt (prime and subprime), the stakes get bigger because the probability of a spillover to the rest of the economy increases. Pay close attention to the various unemployment figures in the US: Are reported job losses running at a reasonable rate, or is employment in outright decline?

At the same time, the rest of the world is trying its best to contribute to global economic growth while simultaneously trying to address some of the world’s financial imbalances, primarily the US current account deficit.

The most recent US current account figure showed the deficit had shrunk from 6.9 percent of GDP in the third quarter of 2006 to 5.8 percent in the fourth. For a profligate economy like the US this is a step in the right direction, one that could be the beginning of more balanced global economic growth going forward.

Foreign trade has helped the US improve its financial position as the booming economies around the world proved hungry for US exports. That process has helped America sustain a stronger growth rate than it otherwise would have this past year.

According to the latest World Bank figures, consumer spending in the emerging world has been exceptionally strong in recent years, offsetting the loss of momentum in US domestic spending. The rate of US consumer spending growth declined from 5.1 percent in 1999 to an average of 3 percent during the last seven years. As a whole, emerging markets consumers represent 19 percent of global consumption as per capita incomes have been rising overall.

US exporters consequently experienced strong growth in output to emerging markets as well as to the rest of the developed world. Developing markets had five representatives among the top 12 contributors to US export growth in 2006.

The world will have to wait and see how the newest made-in-America bubble will play out in terms of consequences for the US domestic economy and the rest of the world–the US is still the biggest economy on the planet, after all, and it also prints the world’s reserve currency.

My view remains that emerging economies in general (Asia and Russia in particular) will emerge much stronger and less damaged, even if the world enters a recession this year, as some market observers expect. Short-term pain in the markets could prove unbearable at times, but the key here is “short-term.”

For the time being, and as I’ve previously outlined (see SRI, 14 March 2007, Stay Cool), my view is that the US economy has a strong chance to recover some of its lost momentum during the second half of 2007.

On the market front, the perspective I described heading into 2007 is largely unchanged (see SRI, 27 December 2006, SRI, Abridged II):

The bottom line, though, is that investors will be able to enjoy good returns in 2007. The key is being correctly positioned and understanding that “good performance” isn’t defined by a straight line higher. Be prepared for volatility.

Obviously the volatility part is slowly becoming the new reality in the world’s markets.

Portfolio Moves

I’m removing ABN AMRO from the Portfolio while the talks for a potential takeover by Barclays continue. I recommended the stock as a turnaround/value play last April after I gathered first-hand reports from colleagues while visiting Europe. In November, I noted (see SRI, 8 November 2006, Earnings:

The company hasn’t been able to perform as well as the sector, as management seems to have had difficulty turning things around. On the other hand, it remains quite attractive on a valuation basis and ABN has potential as an acquisition target.

Well, you also need luck in the markets; the scenario materialized much sooner than anticipated. The stock has provided a 44 percent total return since recommendation. Sell ABN AMRO.

City Developments is also being removed for a 29 percent gain since recommendation five months ago. As I’ve noted (see SRI, 4 October 2006, Portfolio Shuffle, and 11 October 2006, Testing…Testing), the Singapore story has more upside, but the Portfolio is still well exposed to this theme through the remaining Singapore-related recommendations. Sell City Developments.

And Taiwan Semiconductor is up 24 percent since recommendation. I’m booking profits here by selling it from the Alternative Holdings Portfolio. Sell Taiwan Semiconductors.