Financial Sense "Fire the Cannons" by Yiannis Mostrous 05/17/2006

In the early days of The Silk Road Investor, I pointed out that world markets would eventually have to deal with many uncomfortable issues, including the inevitable resolution of the current account deficit; the climax of the red-hot housing action in the US; increasingly sensitive geopolitical risks; the parabolic action in commodities; and rising interest rates. I could name more. SRI therefore monitors leading and other indicators to gauge potential changes in the economic environment that can affect market sentiment.

Looking at the global economy, my assessment remains that it’s performing quite well and can continue its current positive course for some time.

In late February (see Silk Road Investor, 22 February 2006, Still Looking Good), I introduced some forward-looking indicators. Given the market’s solid performance since, a fresh look is in order.

The first is the Economic Cycle Research Institute’s (ECRI) weekly Leading Indicator for the US, which leads GDP by two quarters. Although the indicator caused some concern last year, it’s rebounded smartly and looks healthy. The Conference Board’s Leading Indicator series for the US also looks good, obviously not pointing to a recession.

In Japan--long a SRI favorite--the Organization for Economic Cooperation and Development’s (OECD) leading indicator is also pointing to good growth.

And in Europe, things look even better, with leading indicators strongly rising. The OECD leading indicator for Belgium, which generally leads the rest of Europe, has been rising at a healthy pace, while the German IFO business survey is at a 15-year high.

These indicators can change at any time (and then perhaps inspiring a different attitude toward the market). For now, though, these measures indicate that the global economy has more life.

As the economy remains in a growth mode, global inflation is also cooperating by remaining low, especially at the core level. Yet there’s much talk lately that core inflation isn’t a true measure of inflation because it excludes food and energy. Food and energy are very important in our everyday life, and inflationary pressures there can have adverse consequences for consumer expectations.

I look at the core number to determine if inflation pressures from energy and food feed through to the rest of the Consumer Price Index (CPI) basket. If they do, the situation is worth studying.

Due to the strength in oil prices, the core inflation debate has returned with a vengeance. The fact of the matter is that energy accounts for just 9 percent of the CPI, weakening the energy argument. On the other hand, food accounts for 14 percent of the CPI--it’s obviously a more important factor. Nevertheless, a cursory look at food price indexes (e.g., the Producer Price Index [PPI] for food, farm and import prices) shows clear deceleration, if not outright deflation.

The ECRI future inflation gauge growth rate continues to point downward, indicating that inflationary pressures should remain benign.

As far as I'm concerned, the global economy is growing at a satisfactory pace and inflation is still low. Both circumstances are positive for markets and investor sentiment.

While in London recently I had the opportunity to talk with a group of people in the hedge fund industry, mainly account managers. The bottom line is that, based on our conversations, there's no fear in their thinking. They’re prepared to buy the dips, and they're always open to listening to new investment ideas.

(If you find yourself in London with your young child or grandchild, make sure you take him/her to see Mary Poppins at the Prince Edward Theater. It will be an unforgettable and thrilling experience.)

Looking back at the markets, the mood remains bullish, with commodities leading the pack.

There are quite a few market observers floating the idea of US outperformance this year (note in absolute terms investors did make money in the US market in the past three years, just not as much as those who opted for overseas investing). I disagree with this assessment.

I expect foreign markets to continue to outperform the US for years to come. With respect to Asia, 1998 marked a real bottom for the region’s markets, and a new bull market commenced based on superior growth prospects. Furthermore, although global trade remains one of the key drivers in Asia’s economic growth, the region’s future is rooted in urbanization and domestic consumption. Trade remains one important aspect of domestic consumption, but not the only one.

Thailand remains a preferred market. As anticipated (see Silk Road Investor, 29 March 2006, Right You Are (If You Think You Are)), the political crisis there is on the path to resolution after King Bhumibol Adulyadej’s intervention via a televised address last week.

King Bhumibol Adulyadej’s call for the courts to resolve the political issues should have a positive effect. The King has shown the way; Prime Minister Thaksin Shinawatra’s opponents will be forced to participate in the election process, and Mr. Shinawatra has a legitimate chance to win again. He’d then be able to continue implementing his economic program, which would be bullish for the market. This bank stock remains my favorite in Thailand, and I expect a dramatic run going forward.

Finally, Singapore has performed well as investors are more and more impressed with its success in creating new growth sectors while strengthening its financial services sector.

Think Globally

Are your investment returns becoming stagnant? Or worse yet, have you lost money on Wall Street during the last five years?

Globalization is a powerful trend that is here to stay. In fact, last year alone this trend generated a 58% return in Korea, a 37% return in India, a 161% return in Egypt, and an 83% return in Russia – all while the S&P gained a measly 3%. It’s a trend I expect to continue. The times of US dominance of capital markets are long gone.

When you start thinking globally, your financial perspective changes dramatically. What's domestic, anymore? New York-based oilfield services firm Schlumberger Ltd. earns 78% of their revenue from outside the United States. McDonald's Corp., a hallmark American company if there ever was one, also relies heavily on overseas revenue.

When I research investment opportunities for my loyal subscribers of Silk Road Investor, I don't stop at the US border. Rather than sort stocks by geography, I recommend buying the world's best companies, regardless of where they're based.

Isn't it about time you refused to settle for measely investment returns with the "Dogs of the Dow" on Wall Street that barely cover the rising rate of inflation?

My under-the-radar winners have helped investors rack-up incredible returns to date, including Mitsubishi UFJ Financial Group, which pulled in 124% gains in 11 months. Or LM Ericsson, a Swedish telecom equipment maker that I knew would benefit from Asia’s telecommunications boom... and it did – 78% in 15 months.

I was one of the first advisors to understand and discuss India's tremendous growth prospects, recommending stocks like HDFC Bank way back in early 2003 before the stock shot up over 203 percent.

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