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Martin Weiss: Welcome to the Weiss Global Forum, bringing together our top experts from around the world for this international video conference.
Our mission today is to explore with you a wide range of new global profit opportunities — and pitfalls — for the balance of 2009 and beyond … and to do so in a way you will rarely see on TV, in a newsletter, or from Wall Street.
Unlike what you see on CNBC or Fox News, this is not a debate. Nor is it just academic discussion. Our experts are here to give you clarity of vision and actionable recommendations.
Unlike most, our experts aren’t armchair analysts glued to their computers. They travel to the far corners of the globe, get out into the sticks, and bring back intelligence that’s not available on the Internet, from Bloomberg, or any other public source.
And unlike what you typically get from Wall Street, our experts are not focused just on buy, buy, buy. They also tell you what to sell and when to sell.
Each of these strengths of our presentation today — clarity of vision, actionable buy recommendations, original information, plus the courage and objectivity to issue sell alerts — is especially critical right now as we witness the first phase of a major, millennial shift:
A shift of power, capital, wealth, and investment opportunities …
A shift from economies that are bogged down in debts, deficits — and denial of the dire disasters all around them — to economies that are rich in cash, rich in commodities, and full of confidence in their future …
A wealth shift from the United States and Western Europe to China and Asia — from West to East.
This is probably the most important and sustainable megatrend of our time. And this 1-hour special event is our response.
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Right now, the prospects of everything you earn, own, and invest in depends on getting the answers to these critical questions:
Question #1. The U.S. housing market appears to be stabilizing. Does this mean the crisis is over?
Mike Larson, among the first to warn of the historic real estate bust, is here with me in our studios in Florida, and will give us his answers.
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Question #2. The long-term outlook in the U.S. and Europe seems dismal at best. So why does the economy seem to be temporarily defying gravity? How long could this bear market rally continue? What will be the next shoe to fall?
Claus Vogt, of our Million-Dollar Contrarian Portfolio, joins us via remote video from Berlin, Germany, to tell us about where we’re headed.
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Question #3. China’s economy and stock market are booming again. Why? How long could it last?
Larry Edelson, joining us from his office in Bangkok, provides the answers.
Question #4. Which specific investments are the most likely to give you a solid stake in this monumental West-to-East shift? Larry will name his favorites.
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And Tony Sagami, editor of Asia Stock Alert, will tell us about the unique investment opportunities he has found after multiple trips to China.
Plus, I have a special guest today, one of the nation’s leading experts on hedge funds, who will help outline a broad investment approach to take advantage of the West-to-East shift.
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His name: Monty Agarwal, author of a blockbuster new book due out this year, The Future of Hedge Fund Investing.
Mike, let’s start where this all began, in the U.S. housing market. You called the beginning of this entire crisis months in advance; and since then, you’ve been hailed as one of the nation’s leading experts on real estate.
When CNBC, Fox News, the New York Times, or the Wall Street Journal want candid, no-nonsense analysis of the real estate market, you’re among the very first they call upon, and I see your commentary in the press almost daily.
Mike Larson: But you will be the first to hear what I have to say today: If you’re wondering where will be the next shoe to fall, I can tell you flatly right now that it will probably not be in the U.S. housing market.
Martin: Are you saying the housing crisis is over?
Mike: No, far from it! From the outset, I have said that the fundamental driver of the housing crisis was the bubble in prices, and that the fundamental solution to the housing crisis was sharply lower prices. Now, with the price bust that has swept America, we have that solution. That’s why sales have bottomed. That’s why the supply of homes for sale has topped.
Martin: But have prices bottomed?
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Mike: No, prices have not bottomed. They’ll probably decline further, perhaps by another 5 or 10 percent over the next year.
Martin: Why? I thought you said the supply of homes for sale has topped.
Mike: Yes, supplies have topped but they’re still way too large. We still have about one million too many homes on the market. Plus, you’ve still got massive amounts of option ARMs due to reset and you’ve still got more home foreclosures on the horizon.
But the key is that the foreclosures and the lower prices are now stimulating higher sales volumes and helping to chew away at the huge inventory of unsold homes. Plus, there are several states that act as leading indicators for the U.S. market.
Martin: Which states are those?
Mike: Look at California, where the sales of existing homes have shot up 20 percent year-over-year. In Florida, another sort of ground zero for this housing crisis, sales have risen 28 percent; in Nevada, they’re up 44 percent.
Nationally, new home sales surged 11 percent in May, the biggest monthly rise in eight years. Regionally, new home sales rose 22.6 percent in the West, 29.2 percent in the Northeast, and 43.1 percent in the Midwest.
Martin: What about commercial real estate?
Mike: Still sinking and, as far as I’m concerned, still in big trouble. But I repeat: If there’s new trouble ahead in the economy, the housing sector will not be the main cause. It will most likely come from another source.
Martin: Such as …
Mike: An obvious candidate: the monster federal deficit.
Claus Vogt: May I jump in and say a few words on that? I travel all over Germany. I talk with my colleagues at our bank here daily. I meet with international investors all the time. We are absolutely dumbfounded — not just by the extraordinary size of the federal deficits, but even more so by the dismissive attitude of government authorities toward the deficit.
The U.S. deficit is now closing in on two trillion dollars, and politicians in Washington are sleepwalking through their daily life as if nothing had changed. Tax revenues have just plunged by the biggest amount since 1932 … and Washington is behaving as if it were still business as usual.
Mike: This is not just a political debate or some future disaster. It’s having an immediate impact right now. The deficit is already creating huge supplies of bonds, which are already pushing up long-term interest rates.
This week is a case in point. On Tuesday, they issued $37 billion in 3-year notes. Yesterday, they issued $23 billion in 10-year notes. Today, they came out with another $15 billion in 30-year bonds. That’s $75 billion in new notes and bonds hitting the market in just three days. It’s an avalanche.
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Martin: Mike and Claus, you make this sound like this is strictly a U.S. problem.
Claus: Quite the contrary. Among those of us here in Europe who are not sticking our heads in the sand, the budget deficits in the eurozone are even more shocking than yours in the U.S.
Martin: Because of their size …
Claus: Yes and, more importantly, because the politicians explicitly promised to keep them under clearly defined limits. When they introduced the euro, they created a rule that budget deficits must never exceed 3 percent of GDP in any single eurozone country. Now, they have broken that rule in every single eurozone country.
Martin: By how much?
Claus: By a mile! Among the best countries, deficits are 6 or 7 percent of GDP — in other words, double the limit. In other countries, the deficits are 9 or 10 percent of GDP — or more than triple the limits. And there is no plan to fix this disaster.
Martin: There’s no timeline or distant date in the future for bringing the deficits back under control.
Claus: None whatsoever! All the promises are in the trashcan. The rules are garbage! This is a devastating development for long-term growth.
Martin: I remember back in the 1950s and 1960s, when I lived in Brazil. And this reminds me of the fiscal mess Brazil and other less developed countries faced in those days. How ironic it is that the U.S. and Western Europe are now in the same fiscal rat hole and the same debt trap that those countries were in for many decades! And what’s even more ironic is how Brazil and other so-called “Third World” countries have paid off their foreign debts and gained firm control over their budget deficits. It’s one of the most fundamental reversals of our time.
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Claus: Yes, but let’s look at this from 30,000 feet and let’s ask: What are the two long-term drivers of economic growth? They are population and free markets.
For long-term, vibrant growth, the population structure should ideally form a normal-shaped pyramid.
Look at India — a broad, solid base of young people … a decent middle area of active, productive adults … a smaller layer of retired people … and an even smaller segment of the aged.
This is also similar to the demographic structure of Brazil today: A somewhat smaller group of people under the age of 10, but still a nice, solid base of people under the age of 30, with no large baby-boom generation.
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Unfortunately, that’s not what we see in the U.S. Instead of a broad base of young people, the population is top-heavy with a bulging group of baby boomers.
Nor is it what we see in countries like Germany, where young populations are even smaller and the baby-boomer bulge is even larger.
So the demographics of the U.S. and especially Western Europe do not favor economic growth. To the contrary, they point to economic stagnation.
Second, for vibrant long-term growth, we must have free markets. Free markets are the primary drivers of all the fundamental elements of capitalism, including labor markets and capital markets. But unfortunately, a major dramatic consequence of this credit crisis is that the United States and Europe have taken huge steps to move away from free market policies.
Martin: They say the government’s intrusion into the banking system is just a temporary emergency measure …
Claus: That’s what they say, yes. But rarely do we see governments take control … and then relinquish that control. Almost invariably, when governments move into the private sector, it’s a one-way street or, at best, big steps in and small steps out.
Look at the European Union, for example. The European Union has progressively abandoned free market principles. Instead of healthy growth in production and productivity, the EU has produced exponential growth in another, unwanted product …
Martin: Which is …
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Claus: Legislation! Thousands of new directives, regulations, judgments, and other legal actions — all adding up to higher costs, more inefficiencies, less flexibility, and, ultimately, deeper recessions … or, at best, growth that’s stunted and handicapped.
To understand how serious this is, look back to Germany of the 1950s and 1960s to compare today’s situation to the so-called “economic miracle” of that era. It was not really a miracle. It was merely the logical outcome of a rational policy.
With the irrational, reckless policies we have today, there’s no way we can have that kind of growth in the U.S. or Europe.
Martin: Please break this down to the simplest terms.
Claus: In the simplest terms, back in the 1950 and 1960s, we had people who worked. And they had every incentive to work hard. Today, we have neither the people nor the incentive. In sum, the two most important long-term drivers of growth are absent in the U.S. and Western Europe today! It’s truly frightening.
Martin: What about Eastern Europe?
Claus: As countries like Poland, Hungary, the Czech Republic, and others are integrated into the European Union, they’re getting sucked into the same giant bureaucracy and they’re suffering from the same kind of disincentives for long-term growth.
Martin: So what would you say to U.S. investors?
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Claus: If you’re looking to escape the troubles on your side of the Atlantic, don’t come to Europe! You’d just be jumping from the frying pan into the fire; the housing bubbles in Spain, Portugal, Ireland, and the U.K. were even more extreme than the bubble in the U.S.
Meanwhile, in Germany, we had the post-unification bubble and a long, drawn-out bust that’s still not over.
The bubbles in Eastern Europe were even worse due to huge amounts they borrowed in foreign currencies, like the Swiss Franc and the Japanese yen. Meanwhile, the European banks are three times more leveraged than the big five U.S. banks. In a financial crisis, they’re more likely to collapse. And in a government rescue, they’re a much bigger burden to the government and much bigger drag on growth.
Martin: So basically, cross Europe off the list.
Claus: Yes, with one big exception: Russia. Ironically, despite all its corruption and deficiencies, Russia’s bureaucracy is not destroying wealth. It’s generating wealth.
Moreover, Russia has what China desperately wants: oil and other commodities. If the Chinese growth story continues, Russia’s growth story will continue. I really see it as that easy.
Plus, there’s a strong positive correlation between the oil price and Russia’s stock market and economy. So if you are bullish on oil, you should also be bullish on Russia as a way to leverage the price of oil.
Martin: Larry, you’re out in Bangkok, you see what’s going on. What do you think about what Claus just said?
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Larry Edelson: I agree. I can tell you without hesitation that China’s massive growth machine has been stress-tested by the crisis, and it has passed that great stress test with flying colors. It has proven that its growth is sustainable, and it has launched forward on a new, equally dynamic growth spurt.
Claus: Beware: What looks like healthy growth today could turn into a speculative bubble later.
Larry: At some point, perhaps, but not now! And even if it does, a short-term boom and bust cycle is not going to change the long-term transformation underway.
Martin: Hold that thought, Larry. Monty, among all of us here, you have spent the most time in Asia — not only in India where you were born and brought up, but also in Singapore, Hong Kong, and Japan, where you worked as a portfolio manager for several years.
Monty Agarwal: I see how this discussion is flowing. It’s flowing in the same direction as the millennial shift you cited at the outset — from West to East — first the U.S., then Western Europe, next Eastern Europe and Russia … and now China and East Asia. And it’s going to the BRIC countries: Brazil, Russia, India, and China.
The only comment I want to throw in now is that’s also the direction that sophisticated capital is flowing.
But in this group, I’m the new kid on the block. So I first would like to hear what everyone has to say. Then, I’ll give you my big-picture vision and strategy.
Martin: Sorry to have cut you off, Larry. Go ahead with what you were saying …
Larry: The key point I wanted to make is that while most societies in the West are moving toward more regulation and more government intervention, the trend in China is precisely in the opposite direction — sweeping deregulation.
And while the population dynamics in the West are negative, as Claus pointed out, the dynamics in China are still extremely positive — not only in the structure of the population pyramids, but also in the how they communicate, especially through the Internet.
Martin: So you don’t see the Internet as strictly a technological revolution?
Larry: I never did. It has a much bigger impact than just the latest and greatest tech stocks, whether back in 2000 or today. It has transformed society. I’ve been in China in the rural areas and here in Thailand. It’s just amazing when you see a farmer — who didn’t even have electricity a few years ago — now checking rice prices on the Internet or reviewing his 10 acres of rice paddies with his Garmin GPS.
You have to realize they are jumping from the 19th century straight into the 21st century, virtually leapfrogging the 20th century.
Martin: With the Internet and computers.
Tony Sagami: No, with cell phones! Most people in China and many countries in Asia connect to the Internet through their cell phones. It costs a heck of a lot less to put up a cell tower than to lay down thousands of miles of land lines and, more importantly, a cell phone is much more affordable than a computer.
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Larry: Let’s not get too hung up on technology, and let’s go back to some simple demographics: One out every five people in the world is in China. And worldwide, three out of every five people are in Asia!
And never forget that, just a few years ago, most of this continent was way behind the West. Now, in parallel with the growth of the Internet, China and India have emerged from their socialist regimes and are bursting onto the world stage. It’s a megatrend that will shape the entire century, but it’s barely 15 years old.
Martin: Can we bring this back to the medium-term outlook? First, Claus, give us your medium-term outlook on Europe.
Claus: Medium term, it makes no sense to analyze the European markets separate from the U.S. markets. They are too interdependent. The U.S. leads; Europe follows. We saw this throughout the bear market, and we’ve seen it again in the rally since March.
Right now, the U.S. economy is stabilizing and looks like it has embarked on some sort of a feeble, medium-term recovery. The EU economy will follow suit.
Martin: Larry, Tony, what about China?
Larry: China’s stock market is, again, the single best performing major stock market in the world. It’s up some 87 percent for the year, 133 percent since last November.
Martin: Yes, but if you’re a U.S. investor and you invest in country ETFs, you’ll find that the best performing country ETF this year is the one tied to Brazil, symbol EWZ. Here’s the chart I sent to viewers a couple of weeks ago as part of our quick quiz:
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The Brazil ETF is up 65 percent. The leading China ETF, symbol FXI, is up 40 percent. The ETF linked to the Dow, meanwhile, is up only 3 percent! So, for every $10,000 investors have made in the Dow this year, they could have made $133,000 in the China ETF and $217,000 in the Brazil ETF.
Larry: I’m talking about the Shanghai index. You’re talking about the China ETF available to U.S. investors only. Similar trends, but different numbers. Based on the Shanghai index, the Chinese market is the best performing major market, not the Brazil market.
Martin: OK. But is this trend sustainable?
Larry: Without normal, healthy short-term pullbacks, of course not. With short-term pullbacks, absolutely! Keep in mind that stock markets lead economies, not the other way around. So the strength you’re seeing in China’s stock markets is a sign that the underlying fundamentals of the economy are also growing. Just compare the U.S. GDP to the GDP in China.
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In the first quarter of 2009, while the U.S. was shrinking at an annual pace of 6.4 percent, China’s GDP was the mirror image, growing at an annual pace of 6.1 percent.
In the second quarter, while the U.S. was shrinking at the annual pace of 1.0 percent, China was expanding at an annual rate of 7.9 percent.
And for the year, even if you accept the consensus of U.S. economists, which has proven to be overly optimistic, the U.S. economy will still be down this year. Meanwhile, China will probably grow by 8 or 9 percent.
Martin: What about the slump in Chinese exports?
Larry: We definitely had a slump in Chinese exports, but I don’t think it was nearly as bad as it was made out to be. Throughout the export slump, China was still racking up a huge trade surplus, and the money had to be coming from somewhere.
Plus, China’s export machine is now revving up again. China’s purchasing managers index has risen for the fifth straight month and is now back above the 50 mark, indicating an expansion is underway. In a recent survey, 70 percent of the industries surveyed in July reported a jump in new orders.
Martin: Larry, let’s get down to the bottom line here: How do investors profit from this?
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China’s growth is clearly a big part of the West-to-East shift. What major forces are driving it?
Larry: I count six. The first is credit creation and investment. While credit in the U.S. and Europe was literally drying up, credit in China has been flowing and even accelerating.
Consider this stat for the first half of 2009: New lending by banks grew 201 percent to more than $1 trillion — not just in urban areas but in rural areas as well. To me, this shows that Beijing is following through on its recent promises to channel the urban growth to the country’s 800 million people in rural China. Capital investment in both the urban and rural areas is also soaring, up an average of 33.4 percent.
A key difference with the U.S.: When the Chinese government pumps money into the banks, the banks pump that money straight into the economy.
Tony: The banks are owned by the government. If bankers don’t loan out the money, they get fired. In the U.S., the banks use the money to buy smaller banks or to try to restore their devastated capital …
Martin: Or to pay big bonuses!
Larry: That’s one reason the stimulus in China, unlike the stimulus in the U.S., is having an impact. It’s going into highway development … railways … oil and gas distribution. It’s going into infrastructure that’s producing and distributing wealth. Right now, there are a record 275,000 construction projects underway in China.
Mike: Imagine that, Martin! In the U.S., despite the stimulus, the equivalent number is not only much smaller, but it’s being undercut dramatically due to the continuing slump in commercial real estate. The lenders aren’t lending, and the developers can’t get the money. So the stimulus package in the U.S. is running into big obstacles, with few shovel-ready projects.
Larry: Not in China! The stimulus in China is $586 billion, equal to 13.9 percent of China’s GDP. For comparison’s sake, that would be like Washington coming out with a $2 trillion stimulus package, or 2.5 times more than the Obama package.
Martin: All paid with cash, not debt.
Larry: Exactly. Unlike the U.S., China does not have to borrow the money. They don’t have to rack up a budget deficit. They have the money in their piggy bank in cold hard cash. Their reserve holdings are still rising and just hit $2.13 trillion — up $178 billion in the second quarter, more evidence that the country is still profitable overall.
And as Mike just said, China does not have to scour the country for shovel-ready projects. Shovel-ready projects are everywhere, especially in rural China.
Martin: You said there were six major growth forces. So far you’ve given us two. Could you run through the others please?
Larry: The third is domestic consumption. Beijing has known for quite some time that the country cannot rely on exports forever. So it has been actively promoting domestic consumption for years.
Consider auto sales: Through June of this year, auto sales increased a record 17.7 percent to 6.1 million vehicles, compared to only 4.8 million in the U.S.
Yes, China is now the world’s largest car manufacturer. And this is another megatrend with legs. There are only 10 cars per every 1,000 people in China, compared to 763 in the U.S. So auto industry growth in China is going to be huge for decades.
Martin: 760 cars vs. 10 cars. So you’re saying that, in comparison to the cars per capita in China, the U.S. has 76 times more?!
Larry: Exactly. Tremendous long-term growth potential there!
The fourth growth force is new initiatives with consumer finance and credit. Beijing recently enacted consumer loan reforms that allow credit card companies, including foreign credit card companies, to expand into the financing of durables goods purchases, such as appliances and electronic goods.
Tony: Until recently, Chinese could not buy an A/C unit, a stereo, or a flat screen TV on credit. Now they can.
Larry: And they’re doing so prudently, in my opinion. They’re not allowed to charge more than four times more than the benchmark interest rate, and total credit card balances cannot exceed five times the borrowers’ monthly income.
The fifth growth force, surprisingly, is China’s improving ties with Taiwan. Most people don’t realize how much China and Taiwan are not about to go to war with each other.
They’ve opened up direct commercial flights between the two countries. They’ve agreed to negotiate an economic cooperation agreement. They’re growing closer on all levels — on the verge of becoming important economic allies.
Tony: Many people don’t appreciate that because they think Taiwan is just a small island of little importance. But it’s a major investor in mainland China. Plus, a lot of very large U.S. companies based out of Taiwan are itching to cut deals with China. Taiwan has something China desperately needs: experienced business people!
Larry: You hit the nail right on the head, Tony. To get back to your question Martin, the sixth growth force is China’s currency, the yuan. China knows the dollar’s time as a world reserve currency is running out, and they know the dollar will be supplanted with some type of new reserve currency, perhaps a basket of currencies, including the yuan.
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Monty: Let me add to that. So far, we’ve been talking about macro-economic trends. What I want to talk about briefly is the capital market developments that have been going on in China as well. Along with promoting the yuan, China has been opening up its markets, step by step over the past five years.
This, in turn, is a precursor to increasing the dominance of the yuan in global trade and thereby reducing China’s overreliance on the U.S. dollar as a trading medium.
They started on July 21, 2005, depegging the Chinese yuan to the U.S. dollar and adopting a measured pace of appreciation.
Then they followed up by granting foreign banks licenses to operate domestically and engage in onshore yuan trading activities.
Martin: In China.
Monty: Yes, most of these foreign banks are based in Shanghai, which, as you know, is the financial capital of China.
Next, they have promoted the development of sophisticated instruments for currency trading.
Meanwhile, the Chinese authorities have been using Hong Kong as a testing ground for opening up their capital markets to offshore trading by allowing Hong Kong residents to hold Chinese yuan accounts. I believe that China is probably a couple of years away from completely liberalizing their currency trading, which will increase global trade in foreign holdings of yuan as well.
Larry: They’re already pushing for the yuan to be part of a basket of reserve currencies.
Martin: Do you think China really wants to supplant the dollar with a basket of currencies?
Larry: They don’t want the entire world dependent on the dollar. So the answer is “yes”! The economic planners in Beijing know the dollar’s days are numbered as a reserve currency. But they also know they can’t dump their dollar holdings on the market all at once. They’d be shooting themselves in the foot if they did that. So instead, they’re taking the steps that Monty mentioned and they’re doing one of the smartest things I’ve ever seen any country do.
Martin: And that is …
Larry: They’re using the global financial crisis and this period of weakness in the dollar to conquer the world on the cheap — via major acquisitions of natural resource production.
That does two things for them: It gives them control over global commodities. And it gives them a built-in hedge against a dollar decline. They know what we’ve been saying all along: That when the dollar falls, the price of tangible assets — oil, copper, gold, iron, nickel — all rise.
Now, I think gold will finally bust through the $1,000 mark. Now, other commodities will follow.
Tony: With its foreign acquisitions, Beijing kills two birds with one stone. It virtually corners critical supplies of natural resources and it hedges against its huge exposure to a dollar decline.
Martin: How big is this?
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Larry: Just look at the pace of China’s acquisitions of natural resource companies over the last few years, and it’s obvious: In 2002, it made only one deal; 2003, two deals; 2004, three deals.
Then look what happens: In 2005, 11 deals; 2006, 25 deals; 2007, 33 deals; 2008, 53 deals in natural resource companies.
And not only are there more deals, the average value of each deal is growing by leaps and bounds.
Martin: What about China’s deals in 2009?
Larry: A bit behind in number of deals compared to last year, but the dollar volume should be about double! These deals are being done all over the world — in Brazil, Peru, Venezuela, Australia, Africa. And they’re in virtually all commodities — from oil, soybeans, and copper … to lumber, rubber, wheat, corn, timber, you name it.
Tony: That’s why China’s sovereign fund invested in a 20 percent stake in Blackstone. That investment has taken a bath. But the Chinese don’t mind very much — because they’re getting the knowledge and expertise to make these deals on their own and do it more cheaply.
Martin: Larry, let’s get down to the bottom line here: How do investors profit from this?
Larry: As Tony said before, two birds with one stone — with investments tied to natural resources … and especially to what China needs.
I’m doing it for the same reason as China is buying them — as a hedge against the falling dollar. And because I want to go along for the ride with China as it gobbles up the natural resource supplies. I’m sticking with big-name Chinese companies that are either in natural resources, or making acquisitions, or both.
Martin: Could you name them please, and be specific.
Larry: PetroChina, which just saw a big jump in first-half earnings … CNOOC, which is literally all over the globe looking at oil and gas producers … Chalco, the aluminum company of China, which just had record earnings … BHP … Rio Tinto … and others.
Martin: Tony, you’ve visited China multiple times. Each time, you’ve been among the first to find companies that didn’t show up on Wall Street’s radar screen until months later. Are those the same names Larry is talking about?
Tony: No, they’re different. Don’t get me wrong. I think Larry is right about the opportunities in natural resource stocks. But I come at this from a different angle.
Remember what Claus said about the population curve in China? And remember what Larry said about the boom in domestic consumption?
That’s where I see the biggest and steadiest growth opportunities. I stress the word steady because China isn’t just a story of big opportunities. It’s also a story of big dangers.
Martin: Tell us first about the dangers and then about the opportunities.
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Tony: The biggest danger is trying to just throw a dart at the wall and expect to make money in China. Some sectors in China are doing poorly while others are thriving.
I know the U.S. and Western Europe are beginning to recover a bit. But I’d still avoid Chinese companies that depend too heavily on exports.
Over 100,000 factories have closed in China because of the global recession. And it’s too soon to declare that trend is over. So I’d also stay away from the big shipping companies that transport Chinese goods across the Pacific Ocean.
Martin: So you’re recommending companies in the domestic sector?
Tony: Absolutely, and it’s especially true of retail and construction.
Retail because of urbanization, because of the growing affluence of coastal cities, because of the rapidly expanding middle class in China. There are over 100 million Chinese yuppies — Chuppies — and they are spending lots of money.
That’s why retail sales on a tear — up 15 percent so far over last year.
That’s why property prices are rising again and why property sales are jumping, up 53 percent in the first six months of this year.
That’s why you’ve got income on the rise again, up 11 percent in urban areas and 8.1 percent in rural areas.
Martin: You’ve given us a lot of strong statistics, but name some names.
Tony: In the retail sector, I like China Nepstar. That’s the largest drugstore in China. In fact, China Nepstar is the only national drugstore chain in all of China. Think of it as CVS, Walgreens, and Rite Aid combined.
I also like New Oriental Education. Not only does it run the largest and most popular English language schools all over China … but it also has a virtual monopoly on the administration of the Chinese college entrance exams.
And New Oriental is making a mint. It recently reported some spectacular results — sales were up by 48 percent and profits were up by 50 percent. That type of growth is very hard to find and almost nonexistent in the U.S.
That’s why I call it the single best stock I’ve found in the 30 years I’ve been doing this. Peter Lynch of Fidelity Magellan used to talk about “ten baggers” or stocks that rose by 1,000 percent. No guarantees, of course, but I expect New Oriental to be a ten bagger.
Martin: You visited their classrooms a few years ago.
Tony: Yes. And I had to get through snarling dogs in the back streets of Shanghai to do so. I was surprised: They said, “Mr. Sagami, you are the first analyst to actually visit our classrooms.” Some analysts had visited the company’s home office, but not the actual classroom where their students are.
Martin: And now it’s a big stock, traded very actively. But going beyond that company, what do you see in the other sectors?
Tony: I’m also very high on the construction industry. Remember the 275,000 projects Larry mentioned? Also keep in mind that construction is getting the bulk of China’s $586 billion stimulus.
Martin: Specifically …
Tony: The two most direct beneficiaries are China Railway Construction and China Communications Construction, both traded on the Hong Kong Stock Exchange.
China Railway Construction is the largest builder of railroads in China and also does business in the Middle East, Africa, and other parts of Asia.
China Communication Construction is the largest builders of shipping ports and highways in China.
Martin: Traded in Hong Kong, though.
Tony: I know that stops a lot of people. But it shouldn’t. E*Trade, for example, allows real-time trading on the Hong Kong Stock Exchange for a flat $21.95 per trade. It’s easy, simple, and cheap to buy and sell stocks there.
But if you’re the type of investor that wants to stick to U.S. exchanges, take a look at Duoyuan Global Water, a major maker of water filtration and pollution control equipment. It trades on the NYSE.
China’s rapid industrialization and growth have created a horrible water pollution problem. And the Chinese government is throwing billions at solving it.
Duoyuan Water is making a fortune doing just that. Like New Oriental Education, it recently reported its quarterly results and it had a 32 percent year-over-year growth in revenues with a 49 percent increase in profits.
Plus, if you just want to trade on the NYSE, you could look at ABB Ltd., one of the largest utility construction companies in the world. ABB has been doing business in China since 1909!
Martin: That’s China, Tony, but you’ve been all over Asia. What about the rest of Asia?
Tony: Everybody knows that stock prices follow corporate profits. Show me a company that is growing its profits and I’ll show you a stock that is rising in value.
Plus, show me a country with an expanding economy and I’ll show you rising corporate profits.
But that is not necessarily happening all across Asia … yet.
Martin: Where isn’t it happening yet?
Tony: Any country that’s a big exporter and counts the U.S. as one of its biggest customers has been lagging. U.S. consumers simply weren’t buying as many TVs, cars, clothes, and electronic doodads as they used to.
Martin: You’re talking about which countries specifically?
Tony: Japan, South Korea, Singapore …
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Claus: … which is why you can still buy them more cheaply right now. China has had a huge rally already. Japan, South Korea, and Singapore had a short-term correction, which China did not have. So where you see lagging performance, Tony, I see greater value and more potential for catch-up.
Martin: Tony, your response?
Tony: My father was an old-fashioned Japanese farmer struggling to raise a family in the U.S. One of his favorite sayings was, “Buy your straw hats in January when they’re cheap.”
That’s what Claus is talking about, and it’s a very effective investment strategy.
Martin: What about investing in Japan?
Tony: Although I was born in Japan, I’ve been very negative on the Tokyo market until recently. Now I’m beginning to see a lot more green shoots in Japan than in the U.S.
Japanese manufacturers increased production for a fourth month in a row in June, capping the largest quarterly output expansion in more than 50 years.
In the second quarter, the country’s output climbed 8.3 percent compared to the previous quarter, making it the biggest quarter-on-quarter increase since 1953.
Nippon Steel Corporation, Japan’s largest steel producer, is going to restart two mothballed furnaces in southern Japan and will increase output of crude steel by 40 percent in the July-September quarter.
Honda and Mitsubishi, the second- and third-largest car makers in Japan, have delivered better-than-expected profits.
Stock market gains typically precede economic recovery. If that holds true in Japan, the rise of the 225-issue Nikkei Stock Average to a 10-month high is an encouraging sign.
Claus: Ditto for South Korea! Its manufacturer index hit a low of 44 in January. Since then, it has been rising steadily and is now all the way up to 80.
Same for new orders! That index has rallied all the way from 53 in January to 85 right now.
That’s why I have recommended the South Korea ETF for our portfolio and why I think that ETF is going to be one of the best performers, like China’s, which is up 40 percent this year, and Brazil’s, up 65 percent.
Martin: Thank you, gentlemen, for those recommendations. But our goal today is to go beyond investment tactics and lay the groundwork for a broader, longer term investment strategy.
That’s why I’ve invited Monty Agarwal. Monty is the author of what I think will be the blockbuster book on hedge funds of this decade, The Future of Hedge Fund Investing.
For four years, Monty ran BNP Paribas’ Asian Proprietary Trading Operations out of Singapore, the largest bank in the Eurozone by total assets. He ran Barclay Capital’s Asian proprietary trading out of Tokyo for a year and a half, plus currency options trading for Bankers Trust out of Hong Kong for a year.
Total experience in on the ground in Asia, excluding India, was how much, Monty?
Monty: Nearly seven years.
Martin: Plus, in the U.S., you ran your own Asia-focused hedge fund, one of the few that survived and thrived in the big decline. I think you have a unique perspective on this West-to-East shift, and I wanted to give everyone the opportunity to get it directly from you.
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Monty: I track hedge funds very closely, and it’s no secret that the money flows to Asia Pacific region began in earnest in 2003.
Prior to that, the hedge fund approach to Asia was almost entirely opportunistic, looking to benefit from the occasional crisis. Since 2003, they have looked to Asia for sustainable long-term growth.
Hedge funds and others that manage money for the rich have started opening Asian offices, based in Hong Kong and Singapore.
Back in 1997, when I moved to Asia, I could identify probably no more than 20 hedge fund managers who were physically based within the region. Now GFIA, Asia’s oldest hedge fund consulting firm, estimates that there are around 500 hedge fund managers based in Asia. So just in 10 year’s time, you are looking at 25 times growth.
Larry: Monty, can you track precisely where they’re putting their money?
Monty: No. Given the secretive nature of hedge funds, it is virtually impossible to get an asset allocation breakdown by country. But overall, you’re talking about at least $150 billion, with the majority of non-Japan Asia hedge fund assets deployed in the Greater China region.
Martin: With so many trillions in sovereign funds, that doesn’t sound like much.
Monty: You’re right. But the hedge funds are the trendsetters, and that money is just the vanguard. On the heels of the hedge fund money, you’re seeing institutional money managers — big pension funds and funds of hedge funds — allocating heavily to Asia as well.
The big pension funds are also trendsetters in the institutional money allocation space. Therefore, it is very important to watch the trends set by some of the top pension funds …
Martin: Such as …
Monty: Such as CalPERS, the California Public Employees’ Retirement System. CalPERS manages $176 billion and has moved into ARA Asia Dragon, sponsored by a member of the Cheung Kong Group, one of the leading real estate companies in Asia.
CalPERS’ CIO believes the ultimate development in Asia is “inescapable and compelling.” So they’re likely to put about $5 billion into emerging markets, with about 20 percent or $1 billion into Asia. And I repeat: Although these numbers may sound small, what counts is that they’re trendsetters.
Also, look at OTPP, Ontario Teacher’s Pension Plan! They manage $88 billion and are regarded as one of the savviest investors. OTPP now invests into Asia via 3rd party money managers, like hedge funds. For example, last year they invested close to $200 million into a new fund, called FountainVest, which focuses on targeting small and mid-sized private enterprises in China.
Martin: How do you know this?
Monty: One way I know is because when I ran my hedge fund, Predator Capital, which, as you mentioned, was Asia focused, OTPP was my largest investor.
Martin: A moment ago, you mentioned “funds of hedge funds.” And I know you know a lot about this topic because that’s the primary focus of your new book. Please explain why they are so important.
Monty: Funds of hedge funds are the equivalent of mutual funds in the hedge fund industry. The reason they are so important is because they’re considered the experts in hedge funds. So most of the people who invest in hedge funds do it via funds of hedge funds.
They control 40 percent of all the capital that is deployed in the entire hedge fund industry. So these are pretty big players.
They started allocating to the Asia bucket in 2004, and they have expanded into other asset classes as well. The important point is that, as more capital has flown into Asia, it has lead to capital market development — more instruments and more liquidity.
This, in turn, has opened the door — not just to sophisticated investors, but also to the average American investor who previously might have shied away from these markets because they were either underdeveloped or less reliable.
Martin: In other words, you have long-term investment capital and liquidity that’s flowing into those markets — another aspect of this monumental shift from West to East.
Monty: That’s right, which means we can now build an educated, reasoned long-term investment strategy.
In a nutshell, use the dips caused by financial crisis in the West to buy investments in the East. That’s what China is doing. That’s what the smarter hedge funds are doing as well.
Given the global connection of all the markets, whenever you see scary news in the U.S. or in Europe, it naturally impacts all markets, including Asia. But instead of running away from the markets, go with the flow: move from West to East.
Claus: The markets are not yet decoupled.
Monty: On a day-to-day, week-to-week, even month-to-month basis, no. When the U.S. rises, Asia rises. When Asia falls, the U.S. usually falls. But on a broader time horizon, you see a very different pattern emerging: You see the Western markets zigzagging downward. And you see the Eastern markets zigzagging upward. The zigs and zags are in sync. But the big trend is very different indeed.
Martin: So the strategy is to …
Monty: To summarize, use intermediate rallies in Western markets primarily as selling opportunities. Use dips in Eastern markets primarily as buying opportunities. Step by step, shift more of your portfolio to Asia.
But like Tony said, you can’t do this by throwing darts at the wall. Like in any investment program, you must do it intelligently, with solid research, with prudence.
Another thing I’d like to add: Don’t restrict yourself to just one country on one continent. Beyond China, look at Japan, South Korea, and India.
Martin: And beyond Asia, look at the other BRIC countries, Brazil and Russia.
Claus: And don’t forget one thing: When this starts looking more like a BUBBLE than like a BRIC, don’t forget to sell! Don’t forget to take your profits off the table and put them away in a safe place, ready for the next major investment opportunities.
Martin: I’m counting on you, Claus, and everyone here in this global forum, to let us know when to sell. Thank you, gentlemen. And thank you, our loyal readers and viewers, for joining us today!
