Why the Enron Case is negative for the US and bullish for Asia

The TV news channels have only one story to report about, and it is how the US' seventh largest company could go bankrupt within such a short period of time while the securities regulators, Enron's auditors and its board of directors were all sleeping the slumber of confidence, complacency, and ignorance.

Of course every commentator has some kind of explanation for this financial disaster, but nobody has so far said that Enron is not really the problem, but rather a symptom of the rot and excesses, which occurred in the US bubble economy of the late 1990s and which characterize the entire US capital market.

Enron is not a unique case of accounting irregularities, false reporting and over-leverage, but is simply representative of what most companies have practiced in the last few years in order to artificially boost their earnings with the view of manipulating their share prices higher. The Enron demise will have far reaching implications not only for its dubious management, and the companies and politicians, which had a business relationship with the company, but also for the entire stock market.

The price of a stock or a market depends on fundamentals, but even more importantly on the confidence of the investing public. When investors feel confident they are willing to pay a far higher price for a stock or the entire market than when they lack confidence. Hence when investors feel good about the economy and the outlook for corporate profits they may pay 25 times earnings for the stock market.

Conversely, when their confidence level is low, they may only pay 10 times earnings or less, as was the case for most of the 1970s. Therefore, I feel that the Enron debacle combined with the recent collapse in the price of Tyco, Worldcom, Elan, and other companies such as IBM, which may have had questionable accounting practices, will lead to a lower valuation of US equities in the long run.

I maintain that it is most probable that we have already seen the high for 2002 for the US market in early January when the S&P 500 exceeded 1180. At the same time, I believe that on balance the Enron case is positive for Asian stocks as well as for gold shares. Why? Simply because over the last few years foreign investors have avoided Asian equities on the basis that Asian companies have little transparency and that in Asia corporate governance is poor. But now that it has been exposed that transparency is no better in the US than in Indonesia, money will increasingly flow to Asia where in countries like Indonesia, Thailand and the Philippines valuations are very low.

Thus I continue to recommend selling US equities in the present rally, which might extend into April. In particular we would use the current strength to sell companies, which have questionable accounting practices and which still command high P/Es, such as most high tech companies. At the same time we urge our readers to continue to buy Asian stocks, which have compared to the US a very low valuation.

So what should an investor buy who wants to have an exposure to Asia? The problem for large institutional investors is that the most attractive companies in terms of valuations tend to be small capitalization companies with market values of frequently less than $ 100 million. Still, many large market capitalization companies sell for a discount to comparable companies in the US, and institutions could always invest with a fund that specializes in small cap stocks.

Individual investors could buy a listed Asian fund, which sells at a discount to its net asset value or a basket of individual securities. Closed end funds, which could be bought include the Greater China Fund (GCH), the Singapore Fund (SGF), the MSDW Asia Pacific Fund (APF), the Asia Pacific Fund (APB), the Aberdeen New Dawn Investment Trust (listed in London), and the Jardine Fleming India Fund.

Also, whereas most strategists recommend an overweight position in Hong Kong, Taiwan and South Korea, I prefer the markets of Indonesia, Thailand, the Philippines and India. These markets have far less correlation to the S&P 500 and the NASDAQ than the by the strategists favored markets, are cheaper, and tend to move up when commodity prices strengthen.

At present, my favorite country for investments is Indonesia (along with Russia a prime beneficiary of rising commodity prices), followed by Thailand, India and the Philippines. In Indonesia, we still like Sampoerna (cigarettes), and also a basket of stocks consisting of Telcom, Indosat, Bank Central Asia, Indofood Sukses Makmur (food), Bimantara Citra (conglomerate principally involved in media), Astra Agro Lestari (plantation), Mayora Indah (candies and cookies) Lautan Luas (chemicals), Ramayana Lestari Sentosa (retail), Indofarma, and Kalbe Farma (pharmaceuticals).

In Thailand where 70% of companies have a higher dividend yield than the local interest rates, I recommend Charoen Pokhand Foods (food products), Banpu (power and mining) Serm Suk (Pepsi bottler), Golden Land (real estate), and - just because everybody hates the banks - Thai Farmers Bank. In the Philippines, I like ABS CBN (broadcasting), Jollibee Foods (fast food) and La Tondena Distillers (liquor).

Two caveats however! The above list is just a small sample of a very much larger number of equities, which are now relatively attractive. Individuals should diversify and buy a large basket of different stocks. Moreover, as mentioned before, many of the above listed companies have a very small market capitalization and are, therefore, unsuitable for large financial institutions.

Above, I also mentioned that the Enron case is positive for gold. Why? Enron being representative of the present leverage in the corporate and financial sector shows that the global financial system is simply highly vulnerable, and that in order to support the system central bankers will print money, which in the end will lead to a depreciation of all currencies against hard assets. So I still advise investors to purchase physical gold and also a basket of gold shares.