By Robert Hsu
Robert Hsu's China Strategy

       I expect 2006 to be a great year for us. There's no doubt that the China Miracle will continue to grow full force. We're already off to a great start (our portfolio is up more than 17% in just over two months), but I believe our China stocks will look even more attractive later in the year because the U.S. economy will probably slow down.
       I think the Fed will raise interest rates two more times and then be finished with the current cycle. Now that housing prices are stabilizing, the Fed can ease up, which will be positive for stocks in the first half of the year. However, as the real estate market weakens, consumers will curb spending, and I think that will slow U.S. economic growth from 4% currently to about 2% by the end of the year. U.S. consumers have driven economic growth around the world, so any slowdown in spending will adversely affect earnings and likely be a drag on a lot of U.S. stocks.
       Many analysts think that a weak real estate market is good for stocks, as speculative money turns away from housing and back to the market. That's wishful thinking. If earnings do slow down, I think a lot of investors will decide to just hold more cash, which will probably earn close to 4.5% in interest-bearing accounts by the second half of the year.
       On the bright side, I do not believe we are headed for a recession - thanks in large part to China. With all of the cost savings incurred by companies outsourcing to China, many businesses have excellent balance sheets. I expect strong business spending to offset some of the consumer slowdown and avert a recession.
       All of this makes now a great time to invest in companies benefiting from China's growth. I expect large and mid-cap companies with significant exposure to Asia to benefit from relative economic strength in that part of the world - companies like our current picks Motorola, Yum Brands, National Semiconductor and SanDisk.
       Now let's turn to China and the five major trends I see that will provide us with the best investment opportunities in 2006:
       1. China's insatiable demand for energy, commodities and natural resources will continue to drive prices higher. China is already the world's top consumer of steel, copper, coal, lead - even meat! It is also the number-two user of oil. This growing demand was the chief reason behind the huge worldwide increase in commodity prices over the past three years, and we will see more of the same. Companies controlling the supply of raw materials, like our global mining giants Rio Tinto and BHP Billiton, will benefit. And oil supplier CNOOC, one of the few state-owned enterprises (SOEs) I recommend, should also do very well.
       In fact, CNOOC's recent $2.3 billion bid for a large stake in a Nigerian oil field is further proof that China will continue to buy energy and mining assets overseas to satisfy its growing demand. This strategy resulted in quite a few mergers and acquisitions last year, a trend that should continue in 2006. Many medium-sized oil, gas and mining companies will probably be taken over this year at big premiums, and we'll take advantage of that. Of our current stocks, I think copper giant Phelps Dodge is the best candidate to be bought out a nice premium.
       China's massive growth also requires more and more energy. In an era of high gas prices, dwindling global reserves and environmental problems related to the traditional fossil fuels, alternative energy is hot. Solar energy is particular, which is safe, clean and virtually unlimited, is the hottest right now. That's why I recommended Suntech Power Holdings to you in a Flash Alert on January 12. It's one of the top five solar energy companies in the world, and also one of the few major alternative energy firms showing a profit.
       2. Private businesses will become even more important drivers of growth, displacing the inefficient and wasteful state-owned enterprises. China's 2005 estimated growth rate of 9.8% includes all of the SOEs, which collectively lose money. Sadly, most mutual fund managers and exchange-traded funds (ETFs) investing in China still put their money predominantly in these SOEs. For example, nine of widely held iShares (FTSE/Xinhua China 25 Index Fund's top 10 holdings are SOEs.
       As a rule, we'll stay away from SOEs and make our money investing in foreign companies enjoying success in China as well as China's best and brightest entrepreneurs. The wealthiest man in China right now is 43-year old Dr. Zhengrong Shi, the founder of Suntech. Care to guess how much he's worth? Try $3 billion. An engineer trained in Australia, Shi started Suntech only four years ago and built it into one of the leaders in its industry. From zero to multibillionaire in less than five years - that's the kind of story playing out in China today. (In just a moment, we'll talk about another one of our stocks built by two great entrepreneurs.)
       The good news for us is that I expect more and more of these companies to go public, following in the footsteps of Suntech and Focus Media, which has skyrocketed 50% just since the beginning of this year! I spotted both of these opportunities in my visits to China, long before Wall Street caught on. Rest assured that I - with the help of my team on the ground in China - am watching pending IPOs closely and will be sure to let you know when I see a safe opportunity to profit.
       3. The rise of the middle class and the "Chuppies." China's middle class is already 200 million strong and is made up of mostly young, well-educated professionals capable of and eager to participate in the global economy. That number will continue to increase, making China's middle class a powerful force worldwide. This growing demographic will be behind many of the opportunities we take advantage of - including a company we'll talk about in a moment making semiconductors for a lot of the gadgets being scooped up by China's middle class.
       Within China's middle class, there's another young, urban professional group developing similar to the Yuppies here in the 1980s. I call them Chuppies, and they range from 18 to 45 years old, are also well-educated, live in the first-tier cities and make between $10 thousand and $125 thousand a year. They buy cars and smart phones (and all the latest gadgets), eat at Pizza Hut and drink Starbucks lattes. In other words, they spend even more money.
       Nobody knows for sure how many Chuppies there are today, but I believe it's between 50 million and 100 million. This fast-growing segment of the population embraces American-style consumerism and will become increasingly influential in shaping China's future growth.
       4. The increasing value of China's currency will produce windfall profits for companies and us. I know currency can be a dull subject, but it gets a lot more exciting when it's putting money in your pocket. Over time, I believe China's appreciating currency will boost our profits an additional 50% to 100%.
       China has replaced Japan as the nation with the largest trade surplus with America. As a result, demand for the Chinese yuan is now surging. Now that the government is letting the value of the yuan float (within a certain range), I expect it to rally 10% in 2006 as the U.S. trade deficit with China continues to widen.
       This is great news for any company that gets paid in the yuan, be it Chinese companies themselves or multinational corporation in China. Almost all of the stocks I'm recommending fit this mode, and we'll continue to invest in companies like Yum Brands and Motorola that are making money hand-over-fist in China.
       5. Big opportunities could develop in Taiwan. Relations between Mainland and China and Taiwan have been strained in recent years. I see the situation improving, which would be great news for us as investors.
       The current president of Taiwan, Chen Sui-bien, opposes economic integration with China. However, he is under pressure related to corruption charges. As Chen becomes a lame duck for the remainder of his term, which expires in 2008, I expect pro-China parties in Taiwan to push for more economic ties between the two.
       Although Taiwanese businesses and investors have put nearly $200 billion in China since it opened up in the late 1980s, the current administration makes it almost impossible for the neighboring island to reap the full benefits of China's growth. When these barriers are lifted, as I believe they soon will be, more Taiwanese companies will quickly become attractive investments.
       Editor's Note: Robert Hsu is editor of China Strategy, 9420 Key West Ave., Rockville, MD 20850. Monthly, 1 year, $199. For more information on the China Strategy newsletter visit www.chinaprofitstrategy.com.