MCLEAN, Va.–North Korea finally went ahead with its nuclear test, reminding the world there remains a problem that must be addressed (hopefully through clear-headed negotiating strategies).

When North Korea tested missiles in July, I noted (see SRI, 5 July 2006, Still Leading):

North Korea started playing with its missiles again, reminding us that the world has a lot more problems to solve than people want to believe. Although North Korea is a problem, it’s more of a Korean peninsula problem than anything else.

This isn’t noted to diminish the threat of a desperate regime, but rather to put it into some perspective. The view here remains that North Korea won’t do anything foolish because the Chinese won’t let them. And Kim Jong Il is neither as stupid nor as incompetent as is portrayed by eager commentators in the media.

The main point of that assessment still holds. Everyone expected the regime to go forward with nuclear testing. At the same time, everyone knows that China–and, to a lesser degree, Russia–will be a force keeping Pyongyang in check.

Chinese diplomacy will eventually prove effective in containing the North Korean threat (especially if the US helps). Beijing has made it clear that it won’t tolerate nuclear instability in its backyard.

Although predicting the outcome is impossible, investors should assume the status quo will prevail. Neither China nor South Korea desires or is prepared for a collapse of the regime in North Korea. An outcome of that sort would be a huge and sudden economic burden to South Korea, while China would experience an influx of refugees and lose its geographic buffer.

From an investment perspective, the SRI Portfolio has some exposure to South Korea and the allocation will remain small.

The North Korea incident, along with other developments around the world (e.g., Thailand, Iran, Russia and the new Japanese Prime Minister’s visit to China–more on this next week), underscores the fact that geopolitics is playing an increasingly important factor in investment decisions, particularly for dedicated global investors. Take the time to read SRI’s Geopolitical & Investing reports, including The Dragon And The Eunuch: Wars, Spies And Profits In 21st Century Asia (8 February 2006) and Still Playing The Great Game: Business, Investments And Politics In Central Asia (2 August 2006).

Market Update

The Dow Jones Industrial Average has been making new highs, and as day follows night, we’ve been reminded of the Dow’s shortcomings–i.e., it’s a price-weighted rather than market-weighted index–as well as the fact that other indexes have demonstrated similar resilience.

Though those are valid points, there’s usable information to be drawn from the Dow’s advance. Shorting the market or standing aside are two alternatives based on the Dow’s lofty perch. But look at what’s happening: There’s a rotation underway out of small caps into large caps. In other words, investors are buying large companies, obviously for security reasons.

It’s no secret that small caps trashed big caps during the last five years as investors became increasingly bullish on the global economy. Now that things look a little dicey, people are migrating (for good reason) to the relative safety of the big caps. The same pattern is being repeated in markets around the world, as institutional investors are showing a preference for big cap stocks, be they European, American, Japanese or Singaporean.

Whether this rotation will continue–or if indeed it’s a permanent trend shift–remains to be seen. The main point is that running a portfolio is much different than trading, in the sense that you can’t sell out of every position every time there’s a potential market drop on the horizon.

I alerted SRI readers to what seemed beforehand and then finally developed into a selloff in May in a Flash Alert issued three trading days after the selloff started. This captured the bulk of the move and allowed investors to take profits and trim positions.

And as much as I’d like to repeat that good fortune, there are no guarantees. The business of picking market tops and bottoms is a futile one. The investment advice within SRI comes to you free of absolute convictions. On the macro level, I try to identify long-term trends and favorable market indicators; at the micro level, investment recommendations are based on analysis of individual economies and companies.

In light of my more benign (some would say “bullish”) views regarding the global economy and the markets–i.e., the markets can stay stronger for longer–I’d like to reiterate the alternative scenario I find most credible. At least for the short term, the next most-likely case is that “the major indexes could retest the June lows if markets decide they haven’t properly assessed the dangers of a US economic slowdown.” (See SRI, 30 August 2006, An Alternative Scenario.)

I also wrote in August (see SRI, 23 August 2006, Fall Rally?):

It’s possible that markets are underestimating the slowdown in the US economy, but it’s impossible to define with certainty those factors the markets have discounted and those they haven’t. It’s therefore extremely difficult to quantify any impact. At this juncture, I recommend constraint but not bearishness because the market can rally from here

Although markets have indeed rallied since then, my view is unchanged: Keep a balanced portfolio, and avoid over-leveraged trades on the long or the short side.

More On Singapore

Following up on the property story in Singapore (see SRI, 4 October 2006, Portfolio Shuffle), the Monetary Authority of Singapore (MAS) on October 10 released its monetary policy statement. Most important, the MAS assured that it would continue to manage the Singaporean dollar toward “modest and gradual appreciation.”

This underpins a recommendation I’ve made a couple of times–namely that, as it continues to strengthen, the Singaporean dollar remains a valid alterative to the US dollar. (See the chart below; a falling line indicates Singaporean dollar appreciation.)


Source: Bloomberg

Singapore is still a relatively defensive market that offers low valuations (an average price-to-earnings ratio of 12.6) and good dividend yield support. As the following chart indicates, the overall market dividend yield is a solid 3.91 percent.


Source: Bloomberg

As discussed last week, Singapore’s effort to position itself as a banking, convention and entertainment hub in Asia is a multi-year undertaking, but observers expect it to succeed. The government has initiated several projects that will result in more than SGD15 billion (USD9.8 billion) in investment in the tourism sector during the next five years.

One of the most impressive projects is the Marina Bay Sands (to be built by Las Vegas Sands Corp), which will be ready to open in 2009. The structure will feature three 50-story hotel towers bridged by a two-acre Sky Garden that will offer 360-degree views of the city and the sea. The resort will also include an arts and sciences museum; 1 million square feet of integrated waterside promenade and a shopping arcade; a state-of-the art, 1 million-square-foot convention center; two 2,000-seat theaters; a casino; and a 4,000-car garage. An artist’s rendering of the resort is pictured below.


Source: Moshe Safdie & Associates

An increasing number of multinational corporations are finding it convenient to move their Asian management teams to Singapore (Royal Dutch Shell just announced such a move), and the high-end residential property sector will continue to benefit. Rents in prime areas have risen by 13 percent so far this year, following a rise of 5 percent in 2005. Rents have also been rising in less-desirable areas–21 percent in 2006 after a 5 percent rise last year. Prime office space will also continue to be in high demand.

Keppel Corp, a new member of the SRI Portfolio as of last week, stands to benefit from these developments in Singapore as well as the big residential/commercial boom in the rest of Asia.

Keppel is a multinational company. Through its marine business, the company is a world leader in rig building and has thus benefited from the global energy bull market; its order book is full until 2009.

Keppel also owns 53 percent of Keppel Land (Singapore: KPLD), a big player in the mid- to upper-tier residential property segment and a key supplier of prime office space in Singapore. Through its property subsidiary, Keppel has ventured successfully elsewhere in Asia, namely in China, India, Vietnam, Indonesia and Thailand.

On the office property front (57 percent of Keppel land’s assets), the company–in consortium with SRI Portfolio holding Cheung Kong Holdings–will be developing Singapore’s new Business and Financial Center (BFC) at Marina Bay in the same area as the Marina Bay Sands.


Source: Bloomberg

City Developments, a Short-Term Opportunity in the Alternative Holdings Portfolio, is a more-leveraged play on the theme. City Developments will also benefit from growth in non-prime districts, where 20 percent of its land holdings lie. As always, recommendations in the Alternative Holdings Portfolio are intended to supplement your main holdings.

Finally, in Thailand, King Bhumibol Adulyadej endorsed the list of the new cabinet ministers. The main posts have gone to fairly respected technocrats, which will provide some comfort to the markets, especially if the new leadership demonstrates some decisiveness on the economic development front.

The key post of deputy prime minister and finance minister will be occupied by Thailand’s central bank governor, who’s been credited for crushing inflation. The deputy prime minister and industry minister will be the executive chairman of Bangkok Bank.