By Jason Simpkins
And William Patalon III
Money Morning Editors

Is the hoped-for economic rebound merely a mirage?

And if it is, how should you play it?

For the past few months, optimistic analysts and investors have been scouring the global economy for so-called "green shoots" – a new financial buzzword that refers to any early indicators of a financial recovery.

Investors believe they’ve seen enough evidence that the U.S. economy may be bottoming out to ignite one of the strongest stock-market rallies in years. After closing at a 12-year low on March 9, the Standard & Poor’s 500 Index has soared 32%. The  Dow Jones Industrial Average has zoomed more than 27%, and the tech-laden Nasdaq Composite Index has rocketed 34%.

In a March 15 interview on the CBS show, "60 Minutes," U.S. Federal Reserve Chairman Ben S. Bernanke said the United States escaped a repeat of the 1930s Great Depression. The economic downturn would hit bottom this year, with an actual recovery starting in 2010.

"And I think as those green shoots begin to appear in different markets, and as some confidence begins to come back, that will begin the positive dynamic that brings our economy back," Bernanke told viewers.

But now those "different markets" appear to be sending some troubling signals.

Green Shoots Yield to Red Ink

Last week, Mexico reported that its economy contracted at an annualized rate of 21.5% in the first quarter. The report followed equally dismal reports from Japan, Germany and the United States. Japan – the world’s second largest economy – said its gross domestic product (GDP) contracted at a 15.2% clip, its worst performance since 1955. Germany’s economy shrank at a 14.4% annualized pace, its worst showing since 1970.

In fact, Europe as a whole stumbled in the first quarter, as economic activity in the 16-nation Eurozone fell the most in 13 years. The Eurozone’s economy contracted by 2.5% in the three months that ended March 31.

At home, the U.S. economy contracted by a 6.3% annual rate, with the U.S. Federal Reserve predicting "a gradual recovery" that starts in the second half of this year.

If uncertainty continues to be the watchword, how should investors position themselves?

Staying on the sideline may appear safe, but it’s actually been proven through research to be a risky strategy. For instance, after looking at S&P 500 returns between 1993 and 2007, Davis Advisors Funds found that investors who remained invested and didn’t try and "time" the market ended up being much better off than investors who moved in and out of the market – often missing strong days in the market, as a result, says Wellcap Partners Managing Partner Alan Schram.

Investors who remained invested received an average annualized return of 10.5%. But investors who missed just the best 30 trading days over this stretch saw that return drop all the way down to 2.2%. And the more strong days an investor missed, the worse the returns got, Schram says.

Here’s a summary of the results of that study, looking at the investor’s action and the average annual returns that resulted:

• Stayed the course: 10.5%.
• Missed the 10 best days: 7.1%.
• Missed the 30 best days: 2.2%.
• Missed the best 60 days: (-3.2%).
• Missed the best 90 days: (-7.4%).

Nevertheless, there’s still about $8 trillion sitting on the sidelines – enough to create a sustainable market really should the "green shoots" grow into a full-fledged recovery.

Are Income Stocks the Antidote in a Sick Economy?

OK, so it pays to stay invested – but invested in what? And what if the hoped-for recovery ends up getting blunted? After all, those "green shoots" could easily wither on the vine.
According to Money Morning Contributing Editor Martin Hutchinson, seeking out stocks with high – but sustainable – dividend yields is the perfect strategy for an imperfect market.

Stocks with high-dividend yields are one part of a two-element investing strategy that Hutchinson says can create "permanent wealth" for investors who are willing to follow it through. Gold is the other key part.

Income From Dividends: One Pathway to Permanent Wealth

Dividend payouts are a way that a company’s leadership can signal its confidence in the future, Hutchinson says. A company has to have profits and – just as important – cash flow to finance the quarterly payouts, so a company that is maintaining a high yield is basically letting its investors know that it’s upbeat about its future.

Management is "basically saying to you that we’ll be able to keep paying this going forward," which is a bullish sign, Hutchinson says.

Income is a key component of any investment strategy.

"Dividends create wealth in two ways. First, they provide cash flow that you can either use for living expenses or to reinvest: That means there’s no more having to sell shares, often at a depressed price, to meet your monthly bills, or to finance a vacation or home remodeling," Hutchinson says. "Second, if you buy shares with high dividend yields, there’s a good chance that the market will eventually notice the superior [dividend] payouts, and revalue the shares so that their dividend yield is back down around the market’s average. For a dividend yield to go down in this manner, the stock price has to go up. Once that happens, you have received dividends and capital gains."

While dividends provide income stability, gold provides a hedge against the inflationary pressures that are virtually certain to emanate from the massive amounts of money that the federal bailout and stimulus plans are injecting into the U.S. economy.

The recent surge in the prices of both gold and oil are proof that the markets expect inflation to escalate.

"Gold and gold-based investment – such as gold-mining companies – are an important part of a permanent-wealth-investment strategy because of gold’s historic function as a store of value that is impervious to inflation. At the moment, when inflation is low but there is a big danger of it rising, gold investments are an essential protection for permanent wealth investors," Hutchinson says.

[Editor's Note: When Slate magazine recently set out to identify the stock-market guru who most correctly predicted the stock-market decline that accompanied the current financial crisis, the respected online publication concluded it was Martin Hutchinson, a veteran international investment banker who is one of Money Morning's top forecasters.

It was no surprise to our readers: After all, Hutchinson warned investors about the evils of credit default swaps six months before the complex derivatives did in insurer American International Group Inc. Then, last fall, Hutchinson "called" the market bottom.

Now Hutchinson has developed a strategy for investors to invest their way to "Permanent Wealth" using high-yielding dividend stocks. This strategy is tailor-made for an unpredictable stock market that's back-dropped by an uncertain economy. Just click here to find out about this strategy - or Hutchinson's new service, The Permanent Wealth Investor.]

News and Related Story Links:

• iStockAnalyst:
  Green Shoots Of US Economic Recovery.

• AFP:
  Bernanke sees ‘green shoots’ of US recovery.

• Money Morning Market Analysis:
  What Shape Will the U.S. Recession Take: U, W or ‘Bloody L?’

• Money Morning Market Analysis:
  Is the Stock Market Rally For Real?

• Investment U:
  Sovereign Wealth Funds: $7 Trillion Reasons to Stay Invested.

• Money Morning Special Report:
  Why Dividends and Gold Are the Keys to Permanent Wealth.

• The Huffington Post:
  Timing the Market.

Russia has generated considerable political ill will throughout the former Soviet Union and even in Europe by renationalizing its energy sector – ultimately using such state-run ventures as OAO Gazprom and its resource-rich position as weapons of economic diplomacy.

And now that Russia has formed a state-run grain trader, analysts fear that Moscow is expanding these bare-fisted tactics to its agricultural sector. The enterprise, the Agency for the Regulation of Food Prices, will take control of 28 government-controlled assets, including storage depots, grain elevators, flour mills and export terminals. The agency will control between 40% and 50% of the nation’s cereal exports by 2011.

“The aim of creating the company is quite clear. As grain trade becomes attractive, bureaucrats are looking for ways of making some extra money using government resources,” a market source, speaking on the condition of anonymity, told Reuters.

With food-and-energy commodities trading at near-record levels – even prompting the leader of the United Nation’s World Food Programme to warn that soaring food prices have caused a “silent tsunami” of hunger to sweep the globe – Moscow’s move is viewed with equal measures of concern and moral ire.

However, it is not yet clear whether the Agency for the Regulation of Food Prices will enter the market as a regular commercial player or whether it will simply serve as another state-run resource monopoly akin to Gazprom – Moscow’s energy arm.

“The idea is to manage the assets more efficiently and to generate profit,” a second source told Reuters.  While the source didn’t offer a timeframe, some reports suggest the new state-run firm could be up and running as soon as this fall.

As with energy, Russia has the natural resources to give it the muscle – and the leverage – to carry this off.

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Russia’s farming industry collapsed alongside the Soviet Union in the 1990s, but soaring commodity prices and increased foreign investment have triggered a revival in the nation’s agricultural sector, particularly in the Chernozem, or “black earth,” belt – a tract of particularly fertile soil in southern Russia.

The region used to be known as the “Bread basket of the Soviet Union,” as its nutrient-rich, black soil produced enough grain to not only satisfy the nation’s domestic needs, but generate lavish export revenue as well.

Russia, the world’s fifth-largest exporter of cereals, exported nearly 13 million metric tons of grain in the 2007-2008-crop year, generating $3.5 billion in revenue. Moscow expects to export at least 15 million metric tons in the current 2008-2009 season, and have export levels reach 25 million metric tons in the next five years.

“Russia has this black soil – it’s another resource just like oil and gas,” Victor Nageyev chief agronomist at Heartland Farms, a company that has 75,000 acres of the fertile land in its portfolio, told Sky News. “The land, plus new technologies, should make Russia a world leader again in grain production and exports. Just like it was at the beginning of last century.”

The introduction of modern farming methods has already resulted in a 300% increase in production at Penza – the region currently being worked by Heartland Farms. If such methods were implemented across the entire Chernozem region, Russia could be producing 300 million metric tons of cereals annually, BBC News reported. That would make it the world’s third largest cereal producer behind the United States and China.

However, analysts fear that if Russia does return to its prominent role as a global food supplier, a state-run monopoly like the Agency for the Regulation of Food Prices could use its exports as political leverage – the same way Gazprom has used its energy exports, to meddle in European politics.

Russia’s Export Leverage

Gazprom, which controls 25% of Europe’s gas supply, has routinely jacked up prices and cut off supplies to the region as a means of exerting political leverage over its customers.

Last year, Gazprom threatened to cut off gas shipments to Belarus, and the energy giant followed through with similar threats against the Ukraine as recently as March of this year.

Gazprom reduced natural gas deliveries to Ukraine by a full one quarter in March after accusing the country of failing to pay $600 million in gas bills for the year. After Ukrainian officials failed to turn up for planned talks aimed at ending the pair’s supply dispute, Gazprom threatened to cut supplies by another 25%, reducing the total amount of natural gas to the Ukraine by half.

It was the second time in as many years Gazprom cut gas shipments to the Ukraine, which in 2006 installed a pro-Western government in Kiev.

About 80% of Russian gas supplies to Europe pass through the Ukraine, which puts Naftogaz of Ukraine in a position to siphon off supplies intended for other customers throughout Europe. In January 2006, Russia cut supplies to Ukraine completely for a period of three days, causing gas volumes across Europe to fall, as Ukraine scrambled to satisfy its demand.

Most recently, Gazprom offered to buy all of Libya’s oil and gas exports just as the former terrorist state was beginning to look like a viable alternative for Europe to diversify away from Gazprom’s dominance.

A member of the Organization of Petroleum Exporting Countries, Libya produces 1.7 million barrels of oil each day. The country had total proven oil reserves of 41.5 billion barrels in 2007, and about 53 trillion cubic feet of proven natural gas reserves. Its oil and gas industries earned Libya more than $40 billion in revenue in 2007.

Prior to its offer to buy Libya’s gas exports, Russia agreed to write off $4.5 billion in Libyan Cold War-era debt in exchange for military and civilian contracts for Russian companies. A memorandum of cooperation between Gazprom and Libya’s state energy conglomerate National Oil Corporation (NOC) was one of ten trade, investment and political agreements reached during then-president Vladimir Putin’s two-day visit to Tripoli.

Stroytransgaz OAO, another Russian company, is in talks to build a network of natural gas pipelines on the Mediterranean coast of Libya.

Related Articles and Links:

• Reuters:
  Russia gov’t considers creation of state grain trader

• Sky News:
  Could Russia Feed the World

• BBC News:
  Turning Russia’s rich soil into riches

• Money Morning:
  The New Cold War: How Russia Has Turned Its Energy Exports Into Weapons of Diplomacy

• Money Morning:
  Gazprom Keeps the Heat on Europe by Pressing Libya

• Money Morning:
  Six Ways to Protect Yourself – and Profit – From a Global Food Crisis That’s Here to Stay.
• Money Morning:
  New Pipeline Subverts U.S. Efforts to Diversify Gas Supply.
• Russian Co. of Heartland Farms Ltd:
  Corporate Web Site. 

• Belgian brewer InBev NV announced yesterday (Monday) that it would attempt to remove the entire Anheuser-Busch Cos. Inc. (BUD) board of directors after InBev’s $46.3 billion hostile takeover offer bid was rejected. InBev is seeking to use a process outlined in Anheuser- Busch’s bylaws that allows shareholders to vote on a new board without a meeting, Bloomberg News reported.

• Microsoft Corp. (MSFT) said yesterday (Monday) that it would be willing to reopen talks to buy all or part of Yahoo! Inc. (YHOO), but only if a new Yahoo board is elected, Reuters reported. Carl Icahn, the billionaire financier who owns a 4% stake in Yahoo, has for the past several months been rallying other shareholders to overthrow the current Yahoo board at the company’s August 1 stockholder meeting. Icahn said he had "spoken frequently" to Microsoft CEO Steve Ballmer over the last week. Microsoft walked away after Yahoo rejected a $47.5 billion takeover bid in May.

• Light, sweet crude for August delivery fell $3.92 (2.7%) to settle at $141.37 on the New York Mercantile Exchange yesterday (Monday) after falling as low as $139.50 earlier in the day. Concerns about escalating tensions in the Middle East and tightening supplies sent futures sharply higher last week. Prices dropped after the threat of potential disruptions subsided and investors took profits.

• Merrill Lynch & Co (MER) may write down about $6 billion in the second quarter primarily driven by losses on high-grade collateralized debt obligations, said Citigroup Inc. (C) analyst Prashant Bhatia.  Bhatia also forecast a second quarter loss and widened his 2008 loss per share view, Reuters reported.  

• Shares of mortgage giants Freddie Mac (FRE) and Fannie Mae (FNM) plunged yesterday (Monday) on liquidity concerns. Investors are concerned the two largest U.S. lenders will need to raise additional capital, Bloomberg News reported. Freddie shares shed almost 18%, with a loss of $2.59 to close at $11.91, while Fannie Mae’s shares dropped $3.04, a decline of 16%, to close at $15.74.

• San Francisco Federal Reserve Bank President Janet Yellen said yesterday (Monday) that the U.S. Fed’s monetary policy is shifting "slightly tighter," as inflation concerns mount and start to outweigh worries about economic growth, Reuters reported. "On a continuum I would say things are shifting to somewhat more inflation risk," Yellen told reporters after a speech at the University of California San Diego.

• Gold for August delivery closed down $4.80 to $928.80 an ounce on the New York Mercantile Exchange, MarketWatch reported. Earlier the yellow metal contract had traded as low as $916.60. "Unfortunately, gold doesn’t have any independent thought right now, and is simply tracking what goes on in the dollar market," said Frank McGhee, the head precious metal trader at Chicago-based Integrated Brokerage Services.

• The popular Prius hybrid from Toyota Motor Corp. (ADR: TM) is about to get even greener, according to media reports yesterday (Monday). As early as Spring 2009, Toyota plans to install solar panels on the Prius that will provide energy to power the hybrid’s air-conditioning unit, MarketWatch reported, making Toyota the first major automaker to utilize solar technology.

The news that the London Interbank Offer Rate (LIBOR) system of setting interest rates is running into trouble was surprising at first glance.  It seems some banks are giving phony LIBOR quotations that don’t reflect the true rates at which they accept deposits. In the perfect financial system, beloved of regulators and academics, this kind of discrepancy shouldn’t happen.

In the real world it does, and I’ll explain why.

The LIBOR system was set up in the 1960s, when the market for dollar-denominated bank deposits outside the United States grew big enough to worry about. On a daily basis, the British Bankers Association would go to 16 banks, which were thought to be top quality, and ask those banks at what rate deposits were being offered. Assuming an honest reply, the data would be compiled to determine the average rates at which deposits were offered to prime banks. The average of the 16 banks becomes that day’s LIBOR – for 1-month, 3-month, 6-month or other period deposits.

Should be a foolproof system, right?

Not quite. To see what can go wrong, let me share a little personal story. Ten years ago, when I was working in Zagreb, Croatia, I advised on the establishment of a LIBOR-type market between Croatian banks for 1- and 3-month deposits in Croatian kuna. We called it the "ZIBOR" market. Realizing that very few Croatian banks were solid credit risks at that time, I suggested that the bankers’ association restrict the system to no more than the three top banks.

Naturally, since I was only the advisor, they ignored me and let in all the large members of the association – seven in all.
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The system worked fine for a time, but then a credit crisis struck. NATO got upset about Kosovo and started bombing the neighborhood. Only occasionally did bombs accidentally fall on Croatia, but the bombing played merry hell with Croatia’s tourist business. The result was a liquidity crisis in Croatia, and big trouble in the ZIBOR market.

I heard some grumblings that ZIBOR had become unrealistic and been investigated. There were two problems:

• First, one of the ZIBOR banks, Splitska Banka, was in such horrendous shape that no other bank would offer it deposits at all – not at any rate. Splitska was naturally interested in continuing to participate in the immense honor of the daily ZIBOR fixing, so its dealers would insist on going last. They would ask what the other banks had quoted, and then quote the average. Perfectly sensible solution, as I told everybody, provided none of the other banks took to doing it – it just meant there were only 6 banks really quoting ZIBOR, but six was still plenty.

• The second problem occurred as liquidity got worse, and consisted of banks complaining that they were actually being asked to place deposits. Other banks would ring them up and ask them to place deposits at ZIBOR. They complained that this was impossible, since most days, they hadn’t any money. Admittedly, the ZIBOR "reference amount" (the amount for which the quotation was supposed to be good) was only 100,000 kuna, or about $15,000. But some days even that amount was difficult to find. They wanted to reduce the reference amount to 10,000 kuna ($1,500), presumably so that if they were asked to place a deposit, the bank’s chief executive officer could conceivably raise the money on his credit card!

So much for emerging-markets banking. When I returned to the United States in 2000, I thought I had left all that behind me. Apparently not!

Banks are now apparently making fake LIBOR quotes on the grounds that they don’t want to be thought of as a credit risk, from which other banks would then demand a premium. Just like the old days in Zagreb!

But given the subprime mess, some large banks are rather dodgy credit risks, and they should be paying a modest premium for their deposits. In the 1974 credit crunch, some perfectly respectable Japanese banks paid a premium of as much as 2% for their short-term dollar deposits.

In these volatile markets, any whisper of trouble over a bank makes other banks’ dealers not want to place money with them. Their feeling is that there’s no point in getting fired for doing business with another bank that goes bust, especially as you’d probably be losing your job at the bottom of a bear market, when times are tough. So it’s not surprising that the LIBOR system is wobbling a bit.

Despite its troubled history, Croatia’s ZIBOR has survived to this day. And it’s likely that LIBOR will do the same. However, there needs to be some realistic threat of banks being banned from participating in the LIBOR system if they provide false quotes. There also needs to be some realization that, in a tight market, not all banks will borrow at the same rate.

The real problem is the hundreds of trillions of dollars of derivatives contracts that use LIBOR – $382.3 trillion in interest rate swaps alone at the end of 2007, according to the International Swaps and Derivatives Association Inc. Just a 0.10% error on a six-month deposit, quoting 2.75% when the rate is really 2.85%, may not sound like much, but if it’s repeated over $382.3 trillion in LIBOR quotes for interest-rate-swap contracts it comes to a fair piece of change. A lot of change.  To be precise, we’re talking about $194.3 billion.

Now that’s what I call an accounting error.

It looks to me like it’s a major problem. But it’s one the world will just have to live with.

And there seem to be a lot of those kinds of problems, right now.

News and Related Story Links:

• The Wall Street Journal:
  Bankers cast doubt on key rate amid crisis.

• Forbes.com/AFX News:
  Unicredito’s Splitska Banka attracts 900 million euro bid from SocGen – Radiocor.

The Doha round of global trade negotiations, which for seven years has failed to liberalize agricultural trade, may finally be close to its first conclusive action.

Global food prices, which have surged more than 80% in the past three years, are actually moving the talks forward by eradicating the tariffs and government subsidies that have deadlocked discussions so far. Those involved with the negotiations hope to have a deal done by the time President Bush vacates office in January 2009.

"I am completely convinced that we have it within our means, politically and technically, to finish the Doha round this year," Pascal Lamy, the World Trade Organization’s director-general, said in a statement to the International Monetary Fund’s International Monetary and Financial Committee.

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The World Bank estimates that a deal would add $100 billion a year to a weakening global economy by spurring trade and growth. Proponents of the WTO’s Doha round also say an international compromise would stabilize food markets, lower tariffs, and spur food production.

The round originally began in November 2001, but negotiations have been derailed by the reluctance of wealthier countries to reduce government farming subsidies, and the unwillingness of poorer countries to open their markets to U.S. goods and services.

That may all be about to change, however, as soaring food prices are succeeding where negotiations have failed. Corn has surged 35% in the past year, while the price of rice has doubled. The price of wheat has climbed 181% since 2005.

As a result, food shortages and riots have erupted across the developing world, leading to the large-scale reduction of import duties. India, Indonesia, Peru, Turkey, and Mongolia are among the countries that have reduced or eliminated import tariffs on wheat, corn, soybeans, and flour. A total of 24 nations had reduced duties and value-added taxes as of April 9, the World Bank reported.

At the same time, agricultural subsidies in the United States and European Union are plummeting because farm supports are based on world prices. Subsidies in the United States are expected to fall below $8 billion this year, down from $13 billion in 2005, David Orden, a senior research fellow at the International Food Policy Research Institute told Bloomberg News.

Government assistance to farmers in the European Union fell by $15.7 billion (10 billion euros) from 2004 to 2006, according to the Organization for Economic Cooperation and Development.

Robert Zoellick, president of the World Bank, said that the recent spike in food prices could push 100 million people in low-income countries deeper into poverty, as food costs cut into already meager earnings. Rising prices have already caused rioting in Burkina Faso, Cameroon, Egypt, Indonesia, Mozambique, Senegal, Haiti and others.

"If ever there is a time to cut distorting agricultural subsidies and open markets for food imports, it must be now," Zoellick said. "If not now, when?"

Analysts say that eliminating price-depressing subsidies in wealthier nations could help developing nations boost their exports.

Still, if deeper cuts in farm subsidies are going to work their way through Congress, the United States will require more export opportunities abroad. Services, which account for 70% of the U.S. economy, only account for 30% of exports.

"We would like to see more ambition from the U.S. on agriculture. You know, that’s the linchpin," Christopher Wenk, senior director for international policy at the U.S. Chamber of Commerce, told reporters."In exchange for that ambition on agriculture, we expect more" from developing countries in terms of opening their markets to U.S. goods and services.

The service offers put forward so far have been "absolutely embarrassingly paltry" according to Wenk, who also said that if a deal isn’t done this year it would be substantially longer before a new U.S. administration made the Doha round a priority.

News and Related Story Links:

• Reuters:
  What will Doha really do for world food prices?

• Reuters:
  WTO’s Lamy "convinced" Doha trade deal achievable

• Bloomberg:
  Global Import Barriers Fall as Food Prices Trump Doha

• Money Morning:
  Food Prices Soar as Farmers Bail on Corn

Taiwan is the China investors should be focusing on.

Investors in Taiwan got good news last week when the party that favors closer relations with China won the Taiwanese presidency. The win by Ma Ying-jeou of the Kuomintang party sent the Taiex Index up 4% in one day. The win reduces the risk to Taiwan investments of invasion by the million-strong Chinese Red Army, and it’s always good in these troubled times to see a risk being reduced!

Taiwan is an active democracy, making it a more stable pick for investors. The Kuomintang party is taking over after eight years of rule by the Democratic Progressive Party (DPP). And Taiwan is also much richer than China – its per capita Gross Domestic Product is $29,800 (calculated on a purchasing power parity basis), which is closer to the levels prevailing in Western Europe rather than China’s per capita GDP of $5,300.

Plus, inflation is under control in Taiwan. It’s currently at 1.8% compared to China’s 8.5% – and the United States’ 4.3%. It has $300 billion in international reserves, and very little foreign debt, which cushions the country from being heavily affected by any Western “liquidity crunch.” Taiwanese productivity has consistently grown at more than 4% per annum, more than double the rate in the United States and Western Europe, and its GDP increased 5.5% in 2007 and is expected to grow around 7% in 2008.

As for politics, both Taiwanese political parties are committed to the free market, and the state absorbs only 21% of GDP, making tax levels low. It’s one of the purest free market economies in the world, and likely to remain so.

Commercially, Taiwan’s relations with China are already excellent, and have improved substantially during the period of (theoretically anti-Chinese) DPP rule since 2000. China is Taiwan’s leading export market, with 39% of its exports, up from 22% in 2000. Most large Taiwanese companies have substantial operations in China, using Taiwanese technological excellence and relatively cheap Chinese labor to manufacture sophisticated products for the world market.

Unlike China’s market, Taiwan’s stock market has experienced neither a large run-up nor a big crash (in that respect, it’s done better than Japan, for example, which is off more than 30% from its 2007 high). Taiwan’s Taiex Index is only 12% below its all-time high, up about 98% in the last five years.

Even more interesting, it is currently on a price-earnings ratio of about 11, suggesting that a revival of investor optimism in Taiwan’s future could potentially produce a big run-up.

In short, the Taiwan stock market currently appears to have limited downside and lots of upside, the ideal situation for an investor in a world of difficult markets.

Taiwan Profit Plays

One effective way into the Taiwan market is the iShare MSCI Taiwan Index (EWT), currently trading at only 11 times earnings and yielding a worthwhile 2.5%. Unlike some exchange traded funds (ETFs), this Taiwan ETF has net assets of $2.95 billion, so it has plenty of liquidity, with trading volume averaging 13 million shares per day.

Taiwan’s leading blue-chip stock is Taiwan Semiconductor Mfg. Co. Ltd. (TSM), which is trading at 15 times earnings and yielding 3.5%. The firm is the largest semiconductor fabricator in the world, putting it into the category of “Global Titans” with a market capitalization of $54 billion.

Hon Hai Precision Industries Ltd. (PINK: HNHAF) is higher rated, trading at 18 times earnings with a yield of only 1.4%. However, Hon Hai is one of Taiwan’s foremost growth companies, a diversified high-tech electronics company with top quality design that has expanded production aggressively into China.

As the manufacturer of all three major video game systems on contract for Microsoft Corp. (MSFT), Nintendo Co. Ltd. (OTC:NTDOY) and Sony Corp. (SNE), the firm has a great business model.

And finally, you might look at Siliconware Precision Industries (SPIL), another semiconductor fabricator, which yields a chunky 4.6% and is currently trading at only 8.8 times earnings.

News and Related Story Links:

• Money Morning: The Politics of the “Two Chinas”

• Money Morning:Four Ways to Profit From the “Other China”

• General Mills Inc. (GIS) offset the soaring cost of wheat with cost-cutting measures and increased sales, resulting in a net profit gain of $430 million, or $1.23 a share, a 60.8% increase from its fiscal third quarter the previous year, Reuters reported. The Minneapolis-based food maker expects costs to continue rising, but expects full-year profits of $3.45 to $3.47, on target with analysts’ expectations.

• The world’s largest iron ore producer, Vale (RIO), said it plans to add 62,000 jobs over the next five years, Bloomberg reported. The Brazil-based mining company recently boosted its output to meet soaring global demand. Jobs will be added in Brazil, the United States, England, Australia and Canada.

• Berkshire Hathaway Inc. (BRK.A, BRK.B) and Marmon Holdings, Inc. announced that Berkshire has successfully completed its acquisition of 60% of Marmon for $4.5 billion. The remaining 40% of Marmon will be acquired through staged acquisitions over a five to six years. Marmon Group is an international association of more than 125 manufacturing and service businesses.

• Oil prices pulled back yesterday (Wednesday) after the government released data suggesting that the high price of oil and gasoline are depressing demand. Overall consumption of oil and its products fell by 3.2% over the last four weeks compared to the same period last year, the Energy Information Administration said. Demand for gasoline fell by 1% over the same period.

• Gold futures plummeted to a three-week low yesterday (Wednesday) after a U.S. interest rate cut temporarily calmed distressed financial markets.   Gold for April delivery fell $60.80 to $943.50 on the New York Mercantile Exchange, after trading as low as $940 earlier in the day. Gold hit an all-time high of $1,033.90 on Monday, after emergency action was taken by the U.S. Federal Reserve.

• Shares of Tata Communications Ltd. (TCL) slumped over 17% yesterday (Wednesday), losing $5.07 to close at $24.48 the day of the launch of its global TelePresence network service, which has achieved Cisco Certified TelePresence Connection status, The Financial Express reported. Tata Communications is the first Asia-based service provider to achieve Cisco Certified TelePresence Connection status, which enables the delivery of the Cisco TelePresence solution.

• Speaking at an annual shareholder meeting, Starbucks Corp. (SBUX) Chief Executive Officer Howard Schultz said the retail coffee giant would lower prices and offer discounts in hopes of reaching out to a consumer that is "in a recession", Bloomberg News reported. "We are dealing with things that we haven’t seen before in terms of how people are responding to how tough it is," Schultz said. Starbucks shares are down almost 15% year-to-date.

• Nike Inc. (NKE) sales have reached $1 billion in China, Chief Executive Officer Mark Parker said yesterday (Wednesday) speaking on a conference call, Reuters reported. Sales in China were boosted by a weak greenback and helped fuel a 32% surge in quarterly net profit.

Hong Kong’s Hang Seng Index had its biggest daily loss since the day after the 9/11 terrorist attacks, and has now lost 23% from its Oct. 30 high, crossing the 20% loss threshold that has traditionally signaled a bear market.

“Sentiment is very weak and investors are selling big time,” Mona Chung, who helps manage $2.5 billion at Hong Kong-based Daiwa Asset Management Ltd., told Bloomberg. “If the [United States] goes into recession, undoubtedly that’ll drag down this part of the world.”

The Hang Seng Index lost 5.4%, while the Hang Seng China Enterprises Index [or H-shares Index], which measures the share price of Hong Kong-listed mainland China companies and includes several state-owned firms, lost 6.6%, its biggest decline in over three years.

“[H shares] have held up the most relative to other stocks, so they are playing catch up now,” Andy Mantel, managing director of Pacific Sun Investment Management, told MarketWatch.

China’s Shanghai Composite index declined 2.8%. Japan’s Nikkei index dropped 3.4%.

News and Related Story Links:

• Bloomberg:
  Hong Kong Stocks Have Biggest Drop Since Sept. 11 Attacks
• MarketWatch:
  China shares plunge as big funds head for the exit
• Xinhua
  :Hong Kong stocks close sharply lower

• News Corp. (NWS), the news and media conglomerate controlled by billionaire Rupert Murdoch, has purchased 15% of Premier PREGn.DE, the largest pay-TV broadcaster in Germany. According to Reuters, News Corp. is paying $421.6 million for its stake. Announcing the transaction, Murdoch said that he thought the time was right to invest in Germany. Premier’s main attraction in the crowded marketplace is its rights to show soccer games in Germany’s prestigious Bundesliga league on a pay basis. It has access to the games through an agreement with its competitor, Unitymedia. Unitymedia was the seller in this transaction and Chief Executive Parm Sandu was said to be very happy with the price the company received for the stake. While some analysts are anticipating a takeover, a News Corp. spokesperson said that the company has no interest in increasing its stake beyond 15% at this time. Shares or Premier rose 20% after the announcement.

• Indiabulls Financial Services Ltd. (PINK: IBLFY), India’s second largest consumer finance company, hopes to raise $1 billion dollars to take advantage of rising demand from borrowers in that nation. The company will seek shareholder approval to issue international securities such as foreign currency convertible bonds and global depository receipts. As reported by Bloomberg News, the company plans to focus more on providing consumer lending as India’s middle class is expected to increase tenfold between now and 2025. The Indian economy has experienced 9% growth for three straight years and consumer loan demand is growing at a rapid pace. Indiabulls has already spun off its real estate business and plans to do the same with its securities business. U.S. investment firms Merrill Lynch & Co. Inc. (MER), Goldman Sachs Group Inc. (GS), and Citigroup Inc. (C) hold stakes in the financial service company.

• Nokia Siemens Network, a joint venture between Nokia Corp. (NOK) and Siemens AG (SI), signed a contract yesterday (Monday) with Zain Corp. valued at $935 million for a turnkey 2G/3G mobile telephone network located in the Kingdom of Saudi Arabia.  The deal also includes a five-year managed service contract. Zain, currently Kuwait’s largest mobile operator, paid $6.1 billion for the third mobile license in Saudi Arabia last year. Zain plans to issue shares to help pay for the costs of developing the new network and expects to invest as much as $2 billion into the venture over the next five years. The contract was a key win for Nokia because business in Western Europe and the United States has slowed dramatically as a result of market saturation and weakening economies in those regions. Motorola, Inc. (MOT) also received a contract to provide some of the radio services in the network, but Zain declined to mention the contract’s value.  Nokia Siemens and Motorola outbid Telefonaktiebolaget LM Ericsson (ERIC) and China-based Huawei Technologies Co. Ltd. for the contracts.

• The continuing impact of higher shipping costs took a toll on U.S.-based metal recycler Schnitzer Steel Industries, Inc. (SCHN). Although revenues rose 18% for the quarter and profits rose 23% compared to fiscal year 2007, earnings fell well short of analysts expectations due to the cost of shipping its products. Analysts had expected Schnitzer to report earnings of $1.07 per share, but the results were just $.85 per share for the three-month period. Company President John Carter said that tight availability for shipping had an impact on the quarterly results as well. He said the company had to delay shipments due to unavailability. He expects that revenue to show up in the second quarter of the company’s fiscal year, which ends Feb. 29. As demand continues to push scrap prices higher, a reduction in shipping prices – which have been falling since October – should have a positive impact on the company’s results in the current quarter. The company also announced that it continued its share-buyback program and had purchased 300,000 shares during the quarter at an average share price of $62. An additional 1.9 million shares are still authorized for purchase under the buyback program. In late trading, shares of Schnitzer Steel were down 3.9% to $61.12.

• Tata Motors Ltd. (TTM), the largest truck maker in India has emerged as the favored bidder for the Jaguar and Land Rover units being sold by Ford Motor Co. (F), Reuters reported. Tata was selected over two rival bidding groups, one backed by a private equity fund run by JP Morgan & Chase (JPM) and one from another large Indian auto company backed U.S. private equity fund Apollo Management. Should Tata land Jaguar and Land Rover, it will be able to expand outside of India with two of the best-known luxury brands in the automotive world. Ford is divesting the division in order to focus on its troubled domestic operations. No firm deal has been reached, but now that Tata has emerged as the front-runner, focused talks will begin immediately. The companies expect to have the transaction details finalized in a matter of weeks. A recent report by Merrill Lynch & Co. Inc. (MER), put the combined value of Jaguar and Land Rover at $1.5 billion. This will be a huge loss for Ford, as it paid $2.5 billion for Jaguar in 1989 and $2.75 billion for Land Rover in 2000. While Ford was able to turn Land Rover around to become profitable, Jaguar has been a consistent money loser and has required additional investments of over $2 billion. After the deal is consummated, the only division left from Ford’s attempted overseas diversification will be Volvo Motors, which the company has said is not for sale.

• In other news from the auto industry, Toyota Motor Corp. (TM) has passed Ford Motor Co. (F) as the second-largest automaker in the United States behind General Motors Corp. (GM), the Associated Press reported. Toyota reported that total sales for 2007 were up 3.1% to 2.62 million units while Ford’s overall sales had fallen 12% to 2.59 million units. Ford had been the No. 2 car manufacturer in the United States for 75 years. General Motors remains the domestic leader with 3.7 million vehicles sold in 2007 despite a 6% decline in overall sales. In sales reports released yesterday (Thursday), Ford said that retail sales had dropped 10% while fleet sales dropped 18%. The largest shortfall was in the sales to daily rental car agencies, which fell 32% compared to 2006. Toyota attributed its overall success to the continued growth of the Lexus division, which retained its spot as the best selling luxury car in the United States for the eighth year in a row. It also received a surprisingly strong contribution from the Scion line of compact cars, which sold over 130,000 units. Overall, the combined results for auto sales were the worst since 1998 and many analysts expect the difficult selling environment to continue into 2008. Globally, Toyota is now the world’s largest manufacturer with 9.52 million units ahead of General Motors’ 9.284 million vehicles.

• Beijing, China-based wireless entertainment company KongZhong Corp. (KONG) announced yesterday (Thursday) that it had signed a strategic partnership agreement with China Sports Industry Group Co., Ltd. to explore and develop sports-related content for mobile phones. China Sports is the largest publicly traded company in the sports industry and is controlled by its largest shareholder, the General Administration of Sports of China, a government agency. Nick Yan, president of KhongZhong, said that he was happy with the agreement and pointed out that 2008 is China’s Olympic year when the nation will be on the world’s pinnacle sports stage. Investors were also happy, with KhongZhong shares up over 12% in mid-afternoon trading on the NASDAQ index.

• According to the Financial Times, shares of U.K.-based subprime lender London Scottish Bank PLC continued to fall as the market doesn’t seem to accept management’s assurances that it would address its deepening balance sheet problems. The company recently announced that it would have to take a charge of almost $45 million as loan defaults continued to rise. As a result, the bank has fallen short of the capital standards set by the Financial Services Authority by as much as $26 million. Robin Ashton, the recently appointed chief executive of the troubled lender, has tried to reassure regulators and investors by telling them that the bank has agreements with other banks as well as fixed-term deposits on hand. He said that the liquidity position of London Scottish Bank was as strong as it has ever been. Ashton also pointed out that although the subprime lending divisions were having difficulties, other divisions were strong. The debt-collection division contributes more than 50% of net profits. The bank is expected to reach an agreement on a plan to restore the capital shortfall with the Financial Services Authority by the time it announces year-end results on Jan. 23. Options available include selling the bank outright, a move some analysts think is the most attractive, as well raising capital through a share offering.