5 bubble-proof foreign stocks

So where's all this cash coming from?

We're in the midst of a global liquidity flood. Cash from supersavers like those in China and Japan, cash from higher prices for oil and other commodities, cash from the money supply created to fund the U.S. trade deficit, and last, but certainly not least, cash created by the U.S. Federal Reserve and other global central banks each time they bail the world's financial system out of a crisis. Each time they do that in order to prevent one bursting bubble from taking down the global economy, the central banks simply add to the flood of cash available for the next bubble. So the Asian currency crisis begat the technology bubble, which begat the real-estate bubble, which begat the developing-markets bubble.

A case of bubble fever

Fans of Chinese, Indian, Russian and other developing-country stocks aren't deterred by these gains or by the price-to earnings ratios these stocks now command. So what if stocks on the Shanghai and Shenzhen mainland stock markets are now trading at 50 times projected 2007 earnings per share?

They're just as willing to look past other fundamental danger signs. For instance, Morgan Stanley has calculated that about 30% of profits at mainland Chinese companies listed in Shanghai and Hong Kong come from gains on equity investments. In other words, about a third of these companies' earnings growth, which has powered the stock-market gains in these stocks, comes from the stock market itself. That leaves earnings at these companies very exposed to a downturn in the stock market and raises the odds that any downturn will become self-reinforcing.

But to me the worst sign that investors -- including the professionals -- may be in the grip of bubble fever comes from the increasing popularity of the theory that these developing economies have become independent of any downturn in the U.S. economy. In the jargon of the theory, these economies, so long dependent on exports to U.S. consumers, are now "decoupled" from that market. One figure I see repeatedly comes from a study that shows that every 1 percentage point slowdown in the U.S. economy would lead to just a 0.4 percentage point slowdown in the Chinese economy.

I suppose the prospect of a slowing Chinese economy instead of a crashing one is comforting, but I think investors are kidding themselves if they think they know how a very stressed Chinese economy will react to even a slight slowdown. The economy is still awash in nonperforming loans and technically bankrupt companies. Rural areas are still showing falling real incomes, especially now that food inflation is running at double-digit rates. When the engine is running this fast, any attempt at putting on the brakes produces unforeseen dangers.

We're all safe until the Beijing Olympics

I'm increasingly sorry that I ever wrote a column that argued that nothing bad would happen in the Chinese and global economies until after the Beijing Olympics. That's become the mantra used by any investor who wants to follow the herd but needs the reassurance of a safety net.

Face it. We know from past bubbles that we all can't get out the door first. And we know that predicting the exact cause and timing of a bubble's breaking is impossible. For professional investors, that's less of a problem, because they can spend money to buy sophisticated hedging instruments -- essentially insurance policies. Individual investors, however, tend to rely just on their ability to jump first, which is why so many of them wind up holding the bag when a bubble bursts.

Continued: Five stocks to consider

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