Truly, A World Of Uncertainty

Despite growth in China and India, analysts see no safe harbor. Their advice: Tread carefully, very carefully

Global terrorism, a spike in oil prices, currency gyrations, soaring commodity prices: All these events have dampened investor confidence in the first four months of 2004. International money managers who had hoped this year would bring more gains after a banner 2003 are adjusting their outlook to reflect diminished expectations. Most major markets in Asia and Europe have plateaued in recent months after solid performances last year. There are a few exceptions -- the Indian, Japanese, Peruvian, and Mexican bourses are climbing ever higher. But if there is money to be made, as there always is, finding the right stocks in this year of uncertainty won't be as easy as last year.

Talk to money pros in Asia, Europe, and Latin America, and certain common themes emerge. One is that great swaths of almost every market around the world seem suddenly to depend for their health on China. That's especially true of markets and companies that produce or sell commodities, from scrap steel to oil to grain and cement, which the fast-growing Chinese economy is gobbling up as fast as they can be shipped. But what if the high-speed China train runs off the rails? Prudent investors must think about not only growth opportunities but also defensive plays in order to guard their capital. Gilles du Fretay, who manages $1.6 billion at his Paris-based hedge-fund group HDF Finance, loves the long-term prospects of the Middle Kingdom but is certain there's trouble ahead. "There is a bubble in China, and there will be a bust," he predicts. If he's right, a number of Asian economies -- particularly Japan and South Korea -- will be seriously hurt. And a sudden drop in commodity prices could spread trouble from the copper mines of Chile to the cement factories of Thailand.

WATCHING BEIJING. Although global markets are still keenly attuned to the ups and downs of the $10 trillion U.S. economy, all eyes are on Beijing as it tries to prevent a stoked economy from overheating. No country is more concerned than South Korea, whose benchmark Kospi Index is up 12.2% this year due largely to China's voracious demand for its semiconductors, car parts, and liquid-crystal display panels. South Korean exports to China rose 45% year-on-year in the first three months of 2004. "The Korean economy has been increasingly dependent on its exports to China," says Kang Shin Woo, chief investment officer at PCA Investment Trust Management Co. "A serious slowdown in China will dampen Korea's economic recovery." But he is convinced it won't happen this year.

Every investor's favorite Korean stock is still Samsung Electronics Co., whose 2004 pretax profits are forecast to jump 29%, to about $8 billion, with help from China. Kim Seog Gyu, chief executive officer of B&F Investment Advisory, has sunk 30% of the $210 million he manages into the company. "The most important driver of the Seoul stock market this year will be Samsung," he says. But it isn't just the big guys making money off the Chinese market. Park Kyung Min, CEO of Hangaram Investment Management, likes less well-known stocks such as Nong Shim Co., a maker of spicy noodle products, which saw its Chinese sales jump 38% in 2003.

In Tokyo, the current market buzz is about Chinese-influenced "reflation" plays. China accounted for about a third of the 2.7% growth in Japan's gross domestic product in 2003. And optimists such as Goldman Sachs equity strategist Kathy Matsui think the China trade has ended Japan's deflationary scourge, which has depressed profits and the Nikkei stock average in recent years. After rising in 2003 for the first year since 1999, the benchmark index is up a further 13% so far this year. Matsui and her team recently identified 20 companies likely to be big beneficiaries of sales to China in 2004. Mitsubishi Chemical Corp. and Mitsui Chemicals, she says, will benefit greatly from the increased demand and pricing power for petrochemicals and plastics. Mitsubishi Chemical, in particular, also looks like a bargain for a Japanese blue chip as it trades at a price-earnings ratio of 16.5 times its expected 2004 profits.

DEALS ON PAPER. Looking for more commodity-related stock picks? There's no shortage. In Brazil, steel producer Companhia Siderúrgica Nacional has seen its stock price rise 27.2% this year on strong international demand. With a price-earnings ratio of 9 times its expected 2004 income, CSN is a relative bargain. But for investors who want to protect themselves in the event of a slowdown in Chinese demand, Damian Fraser, head of Latin American equity research for UBS Securities in Mexico City, likes Brazilian paper maker Votorantim Celulose e Papel, which has a p-e ratio of only 6.4 and whose share price is up 11% so far this year.

China's hunger for oil and gas to run factories and heat homes has also helped push up that sector. Indeed, analysts have stopped predicting that oil will soon fall from the current $33 a barrel to its historical average of around $20. The state-run oil companies of Brazil and Mexico, Petrobras Brasileiro and unlisted Petróleos Mexicanos, like all other world oil companies, are set to benefit from the rise in oil prices. UBS' Fraser points out Petrobras, which is publicly traded, has great cash flow and a p-e ratio of 6.3. But Jason James, who heads global equity strategy at HSBC Holdings PLC in London, likes the British-Dutch oil giant Royal Dutch/Shell. It's a gutsy call because the company is in the midst of a major scandal over the accounting treatment of its oil reserves and has seen its share price drop 12% this year. The stock "has been beaten down so much that it is now worth buying," James says.

Oil also buoys one of the world's best-performing markets, Russia, whose benchmark RTS index is up 34% so far this year. Nevertheless, some stocks still look cheap, says William F. Browder, CEO of Hermitage Capital Management Ltd. He likes giant Gazprom because "it has the biggest reserves in the world at a 98% discount" compared with the share prices of Western oil majors. Browder is big, too, on Russia's No. 3 oil company, Surgutneftegas, which he figures is trading at less than its true value, in large part because its confusing ownership structure has put off investors. Al Breach, head of research for Moscow investment bank Brunswick UBS, recommends Lukoil, now learning from sector rivals by implementing corporate reforms and hiring Western service companies. "Lukoil has a great resource base and has started to accelerate its growth," he says.

TEXT MESSAGING. What other sectors entice? Although the glory days of 1999-2000 are gone, there are still some hot telecom picks around the world. In Russia, Breach likes Moscow's fixed-line telco MGTS, which is a good play on rising incomes in the capital and looks cheap compared with emerging-market peers. In Asia and Europe, demand for camera-equipped mobile phones is surging. That's good news for companies such as Britain's Vodafone and mm02, which sell wireless services, and companies in Asia that make the phones. HSBC's James thinks average usage, and thus profits, will continue to improve as more consumers snap photos and do text messaging on their phones.

In Asia telecom, Ajay Kapur, Citigroup Smith Barney's Asian equity strategist, likes Taiwan fixed-line operator Chunghwa Telecom Co., which boasts a 6.6% dividend yield, and Telekomunikasi Indonesia, which enjoys a monopoly for fixed-line phone service. He also thinks India is on the verge of an explosion in mobile-phone demand, with subscribers expected to double, to 60 million, by 2006. One company that will benefit: Bharti Telecom, one of the three biggest mobile-phone companies. "India's wireless market is in a sweet spot," Kapur says.

Beyond China-related shares, oil, and telecom, the prospects for markets are uncertain at best, particularly in Europe. There, the 13% appreciation of the euro vs. the dollar over the past year continues to weigh on exporters. And the European Central Bank's latest refusal to lower interest rates has deepened the gloom in the rest of the business world. Although some optimistic analysts say European equities are set to rise as much as 10% this year, Subhajit Gupta, director of Standard & Poor's Equity Research in London, has a more muted outlook. Gupta likes cyclicals and defensive stocks such as French food and beverage group Danone and the Netherlands' Heineken. "If you want to go slightly fancier, we like Italy's Luxottica," the world's largest manufacturer of eyeglass frames, Gupta says. He is also a fan of EADS, the Franco-German-Spanish aerospace group that controls Airbus, which, he notes, is "positioned very well" against American archrival Boeing Co.

A bright spot in the New World is Mexico, which is outpacing Brazil in terms of stock gains. Low interest rates and rapidly expanding consumer credit should benefit companies such as Grupo Televisa, Mexico's biggest TV network and one of the country's top advertising vehicles. Televisa, whose ADRs are up 18.2% year-to-date, recently announced plans to expand in the fast-growing U.S. Hispanic market through its partial ownership of Spanish network Univision. Another promising consumer play is brewer Femsa, the No. 2 beer company in Mexico, which exports the Dos Equis and Tecate brands and whose ADRs are up 31% so far this year.

Overall, investment professionals find themselves in a quandary. Sure, the U.S. economy is in recovery, Japan has finally turned around, China and India are booming, and consumers around the world remain in a buying mood. But the most sober analysts believe that many of these global economic gains are already priced into the markets. As a result, their advice, more than ever, is to proceed for the rest of this year -- and perhaps into 2005 -- with caution.

By Brian Bremner in Tokyo, with Moon Ihlwan in Seoul, Laura Cohn in London, Geri Smith in Mexico City, Jason Bush in Moscow, John Rossant in Paris, and Frederik Balfour in Hong Kong

    Before it's here, it's on the Bloomberg Terminal.