Thank you for your comments Eric and I would like to apologize for taking so long with this article. For investment ideas, I must first establish a few things about my approach. First, I take the top-down approach. This means that I start with the high level looking at the big picture to narrow down of areas of possible interest whether it be in a sector region, industry or both. Secondly, I believe in value investing. From Ben Graham to Warren Buffett, this style has stood the test of time. Of course, this is not the only style that works, but it’s just the style that I prefer.

Talks of “Green shoots”

The general consensus is that the worst of the crisis is over and there are signs of “Green shoots” in our economic recovery. I agree that we are almost through with the worst of the crisis. By worst, I mean that the economy is no longer in free fall albeit the global economy is still contracting. U.S. unemployment is currently at 9.5% and experts see that it should top at 10.5%. We can almost put the wave of bankruptcies behind us. Prediction on when we’ll bottom ranges from the end of this year to Q2 of 2010.

I want to make it very clear that hitting the bottom should not be interpreted as the beginning of a rebound. The world is not riding through a business cycle but is amidst a paradigm shift. The economy will rebound again. The problem is timing. The economy collapsed before the next engine of growth was fully ready to be dispatched.

American consumers – an engine with too much mileage

American consumers make up roughly 20% of the world economy and this group is financially ill. Timothy Geithner, the U.S. Secretary of State, was loud and clear when he stated that the world should not rely on U.S. consumers to lead the recovery. We all need to take this statement very seriously. Aside from fiscal and monetary policies, the success of any government stimulus plan rests on the general public’s confidence and policymakers have every reason to want to drive up public confidence. If policymakers are saying “don’t look at us, go find someone else to lead the economy”, mark their words for it.

U.S. consumers are changing their habits. The savings rate in the U.S. has not been positive for a long time. They are spending less and will very likely keep this habit after the crisis is over. For almost a quarter of a century, money has been growing faster than the economy by approximately 6% a year. With U.S. debt expected to reach 100% of GDP during Obama’s presidency, Americans have no choice but to continue to be thrifty for many years to come; this is the age of deleveraging. One columnist pointed out that this unwinding will continue until the year 2018.

China, the next engine?

With American consumers pulling the plug, the world is looking to China to lead the recovery. China has the world’s largest population and their GDP per capita is roughly 7% vs. the U.S. China’s standard of living will catch up to the U.S. The world economy has a lot of potential. If you’re a value investor, the next couple of years should be a good time to go shopping. However, there is a timing issue in the short run counting on China to lead us out of this mess.

While growth in China is strong, it is not invincible. For every 1% drop in spending by American consumers, Chinese consumers need to raise their spending by 5% just to keep world GDP from declining. In tough times, the mentality is to save as much as possible in anticipation of rainy days ahead. On top of that, the Chinese have a high propensity to save even in good times. Unless you can convince 1.3 billion Chinese people to go out there and spend 5% more, talks of China leading us out of this is more of a hope.

Here’s something that you should know about the Chinese economy; it is not fully market driven yet, the expected growth rate is 8% and the government is willing to use its reserves that it has accumulated from years of trade surplus to reach its target. Simply put, some of the growth from the world’s economic superstar is artificial. Many entrepreneurs have shut down their factories and shed many jobs in the process (and you expect Chinese consumers to go out on a shopping frenzy?) On top of this, China is imposing stricter environmental regulations, putting further pressure on the manufacturing sector. China has its own share of problems that it needs to deal with. This super engine is still under development.

The road to recovery

We can still expect the recovery to begin in China, but just don’t expect it to be explosive as it has been in the last decade. China cannot convert its export driven economy to a consumer driven economy overnight. Luckily for China, the government has ample foreign reserves (almost US$2 trillion) and they actually need to spend money on infrastructure. Also, with commodities on the cheap, one can hope that Chinese consumers will be more willing to open their wallets gradually. One concern is that global trade is breaking down, meaning that what happens in one country has less impact on others. Can we interpret a recovery in China as a recovery as a global recovery? I have my doubts.

So what does this mean to your portfolio? I will discuss it in part two.

I have been asked as to why it’s taking me so long with this article. Recently, I’ve been bogged down by some personal stuff. One of the suggestions that I got is to post weekly updates on key world events with some short commentary while I write the big articles. I think that’s a great suggestion. Please check back weekly for updates.

Thanks for your support!!

P.S. Thanks to Michael Jackson for everything he’s brought to this world. Rest in peace Michael.