Market Outlook: 01-02-08

Robert Hsu, January 09, 2008

Happy New Year! My new year's resolution is to keep bringing you exciting investment opportunities in the world's most dynamic economies.

Speaking of dynamic economies, I'd like to start the year by looking back at the 2007 stock market performance of some of the world's fastest-growing countries. China in particular had a terrific year because of continued economic strength, great corporate earnings and favorable demographics. Another catalyst that drove Chinese stocks higher is currency appreciation. The Chinese yuan climbed steadily and ended the year with a 7% advance. Last week alone, the yuan gained 0.9% to 7.3041 per dollar, its biggest weekly gain since the end of its peg to the U.S. dollar in July 2005.

The yuan climbed twice as fast in 2007 as it did in 2006 because the Chinese government actively tried to curb inflation and cut a record trade surplus that has strained ties with the U.S. and Europe. This currency appreciation should continue, and I'm looking for a 7%–8% appreciation in 2008. The strong Chinese currency means that I'll be looking for more Asia Edge investment opportunities in China this year.

I do want to point out that the weakest Asian economy in 2007 was Japan. Japan's poor market performance last year actually dragged down the MSCI Asia Pacific Index. The country's Nikkei 225 Stock Average Index posted its first annual decline in five years, falling 11%. (But if we take out Japan, the Asia Pacific Index actually climbed 32% in 2007!) Japan's sagging market is the main reason why we don't own any Japanese plays in our Asia Edge portfolio. I expect us to continue to steer clear of Japan in 2008. The country's economy is doing poorly because of structural social problems.

I believe we'll continue to see foreign markets outperform the U.S. indexes in 2008, and here's why.

Housing Problems to Continue Weighing on U.S. Economy in '08

It's a new year, but the same old U.S. problems in housing and financial services remain. Sales of new homes in the U.S. fell to a 12-year low in November. Purchases dropped 9% to an annual pace of 647,000, and October sales were also revised lower.

The median home price fell 0.4% from November 2006 to $239,100. New-home sales are down 25.4% so far this year, heading for the biggest annual decline since 1963, and will probably go down again in 2008. Meanwhile, existing home sales in November were down 20% from a year ago, and the median home price fell 3.3% to $210,200. Home sales are now down 31% from their July 2005 peak. Home prices probably have more downside before sales pick up again and this will continue to drag on the markets.

According to a report last week by S&P/Case-Shiller, home prices in 20 metropolitan areas fell 6.1% in the 12 months prior to October, the most in six years. By that measure, the S&P/Case-Shiller index is only down a total of 6.6%, far less than the 15% to 20% peak-to-trough decline in past cycles. Given the increasing inventory in unsold homes, it's unlikely that the U.S. housing market hasn't bottomed yet.

The housing slump and related financial services industry slowdown will be a drag on U.S. economic growth. The weak housing market could undermine consumer spending, which makes up two-thirds of the economy. After strong 4.9% growth in the third quarter, U.S. economic growth will likely slow down this year.

The silver lining to this dark cloud is that I don't think we'll see a recession in the U.S. because economic growth in other parts of the world -- particularly in Asia -- is simply too strong. I expect more interest rate cuts from the Federal Reserve in 2008 to prevent a recession, which will cause the U.S. dollar to fall further against other major currencies. In 2008, it will be more important than ever for investors to own Asian and global commodity stocks. To find out my top picks in Asia and global commodities, become a subscriber to Asia Edge.

Right now I remain a bit cautious about global stock markets. Although I'm still confident about our ability to make double-digit gains this year, the earnings slump in the U.S. will likely make 2008 a tougher year than 2007. But, given the sell-off we saw in November and December, I think it's safe to start buying new stocks.

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