FALLS CHURCH, Va.–Next week I’ll start rolling out macro and micro ideas for 2007, including assessments of the US economy, the global economy and the status of global markets as we prepare to put another year behind us. I’ll also take a look back at 2006.

In the meantime, we’ve entered that part of the calendar when Asian markets perform best—specifically, the November-to-January stretch. The Asia ex-Japan market index has advanced 14 times in the past 18 years, returning 3 percent on average.

Market statistics indicate that Malaysia, Singapore, Hong Kong and India are poised to post strong numbers during this period. Historically, Indonesia and Thailand have put up the best numbers. With regard to specific market sectors, real estate, financials (including banks and other services) and technology usually fare best.

Although the statistical probabilities currently forecast strong Asian performance, it is by no means a certainty. Furthermore, cheaper markets usually outperform more-expensive ones.

According to my analysis, Taiwan, Hong Kong, Malaysia and Singapore also look to be supported by valuations–i.e., they’re relatively cheap. Given that Asia had an excellent November valuations should play an important role once again. Among the frontrunners for strong performance, Taiwan and Malaysia are the cheapest markets overall right now.

When it comes to current market conditions, as I noted last week (see SRI, 29 November 2006, Then And Now), year-to-date net foreign flows to the region stand at around 40 percent of 2005 levels, indicating that foreign investors haven’t really kept up with the rally. Consequently, there’s a lot of room for liquidity to improve, and market participants attempting to make their numbers should provide Asian markets with extra strength.

My recent work also supports my long-held view that 2007 should be a positive year for Asian markets. The region continues to exhibit superior GDP growth, good profitability (although there’s more to be done here) and generally low or declining interest rates. I’ll have more on this in the next couple issues.

Positioning for the usually strong November-to-January season–as far as the SRI Portfolios are concerned–isn’t based on making a quick profit. The factors supporting seasonal strength also support my bullish long-term view of the future of Asian economies and markets.

The SRI Portfolios (the main portfolio as well as the Alternative Holdings) are well positioned for this period of strength, and, most important, there’s no need to materially alter our positions to fit the season.

Given the statistics referenced above and my work on valuations, both Portfolios feature the appropriate stocks. As Taiwan, Hong Kong, Malaysia and Singapore represent the best values, investors interested in adding to positions should do so.

AU Optronics and Taiwan Semiconductor are SRI’s technology stocks in Taiwan, while United Overseas Bank, Keppel Corp and City Developments are the financial/real estate/industrial plays.

SRI’s exposure to the Hong Kong economy and the Hong Kong/China real estate market comes through Cheung Kong, which has been active in its real estate deals. Its land bank is now one of the biggest in China and Hong Kong.

Hong Kong remains one of the main avenues to China; it still handles a significant amount of offshore trade with the mainland, and it remains the most-important financial hub in Asia. A predominantly service-based economy, Hong Kong will prove fairly resilient but not immune if global economic slowdown happens in 2007.

Hong Kong is on a structural improvement path and, 10 years after the crisis of 1997, its economy looks solid. Third quarter GDP was quite strong: The economy grew by 6.8 percent year-over-year, driven mainly by private investment (up 4 percent) and consumption (up 12.7 percent). Unemployment continues to decrease while wages are expected to grow, thus helping consumption. That pattern should continue next year.

The Malaysian market has broken above long-term resistance, as indicated in the chart below. It’s now potentially even more profitable for US-based investors. Exposure to a market that’s usually a strong performer this time of the year could be beneficial.


Source: Bloomberg

I haven’t recommended Malaysia this year because its economy (though one of the most open in Asia) needs to do more if it’s to move forward. Progressive ideas aren’t popular, and changes haven’t happened fast enough. The stock market has been losing ground–trading values are now a third those of Singapore and half of Thailand. Malaysia was the second-largest in market capitalization terms in Asia in 1996, but it’s slipped to sixth place today.

Although Malaysia hasn’t figured in SRI’s main Long-Term Portfolio, there’s no reason why it shouldn’t be included in the Alternative Holdings Portfolio.

It’s difficult to trade Malaysian stocks in the US, but the iShares MSCI Malaysia Index Fund (NYSE: EWM) is a sufficient vehicle; this particular basket of stocks constitutes overweight companies I favor in the market, including Malayan Banking (Malaysia: MAY), Bumiputra-Commerce (Malaysia: CAHB) and IOI Corp (Malaysia: IOI). Investors based outside the US can buy those companies individually. Buy Malaysia.

On a more macro issue, many readers have noted, in the wake of last week’s discussion (see SRI, 29 November 2006, Then And Now), that Asian currencies are looking a little stretched.

I agree that there could be a tactical reversal, but my analysis is based on the context of a long-term structural change taking place in Asia. Stronger currencies in the region are part of this change. Stronger currencies will also help domestic consumption (though the institutional framework must also continue to improve); this is one of the reasons that SRI’s Long-Term Holdings is currently overweight, domestic-related plays.

The chart below depicts the Asian Dollar Index, a trade- and liquidity-weighted index of 10 major Asian currencies (excluding Japan). I included a version of the same chart last week depicting a shorter time frame, but the longer-term chart allows you to see that the Asian currencies–though perhaps stretched in the short-term–are looking perfectly normal in their ascent.


Source: Bloomberg

Portfolio Moves

I’m selling two stocks from the Alternative Holdings Portfolio this week, ASML (recommended August 30) and Wimm-Bill-Dann Foods (recommended June 28). ASML is up about 15 percent, while WBD has returned approximately 42 percent. These are tactical moves, as some of the recommendations in the Alternative Holdings Portfolio are short-term in nature.

Several investors who are following the SRI model and are therefore overweight Asia in particular and other non-US markets in general have asked for a “natural trade” in the US to hedge their positions.

Shorting the S&P 500 is one obvious example. Not only would such a move provide balance to a long-only Asia overweight portfolio on the downside, it would also underperform on the upside, too. Shorting US consumer discretionary stocks—a vulnerable part of the US market—would be a more-leveraged play.

I’m adding such a position to the Permanent Hedges through Consumer Discretionary SPDR (AMEX: XLY).

This is a hedging short to a long-only Asia overweight portfolio and should be viewed as such. Outright shorting could be extremely dangerous at this juncture, although if done right, it can produce solid results.

Short Consumer Discretionary SPDR.


Source: Bloomberg

Technical Issues

SRI has one main portfolio, the Long-Term Portfolio, and an alternative portfolio, Alternative Holdings-Permanent Hedges. Investors should look first to the Long-Term Portfolio for asset allocation in the markets covered here.

In the Alternative Holdings-Permanent Hedges Portfolio, readers can track permanent hedges and shorter-term recommendations. It also includes companies I’ve recommended for longer term or a more-fundamental reason, but have not added to the Long-Term Portfolio; for example, Lukoil provides extra exposure to a favored theme.

A new feature has been added to the Web site. On the left-hand side of the screen, under the title “Portfolio Performance,” readers can get a snapshot of the SRI Portfolio’s return versus other major indexes. You’ll also find an explanation of the way I view the investment process. (This is especially helpful to new readers.)

On the Portfolio page, you can click on the asterisk next to each holding to review the original commentary and recommendation. We plan to enhance the Portfolio table with extra features as soon as our IT guys give us the OK.

Many readers have requested information on brokers that can better execute SRI recommendations. Click the headline “Resources” and see “Brokers & Services.”

E*Trade is a mainstream broker that can now handle some international trading online. Commissions are slightly higher, but the Web site is particularly easy to use and includes solid news and quote feeds for most foreign markets.

According to a recent Wall Street Journal article, Fidelity has seen a fourfold increase in customer requests for international stock purchases. As a result, it’s beefed up its customer service staff to handle the transactions. You can buy foreign stocks through Fidelity by calling the broker directly.

If you’ve had positive experiences buying foreign stocks with other brokers, please drop me an e-mail and I’ll include them in an upcoming issue. And if you plan on getting into some of my non-US traded stocks, be sure to check out your current broker’s capabilities.