Cabot Explorer Issue: August 1, 2024

Portfolio Changes: Buy iShares MSCI India Small-Cap ETF (SMIN)

Big Tech Stock Pull Back as Singapore Signals Support

Explorer stocks gained ground this week as market sentiment improved along with the odds of a Fed rate cut this fall.

I’ve been encouraging you to lighten up on some of the Magnificent Seven stocks over the last month or so. In just the last two weeks, these stocks have lost over $1.6 trillion in market value as market enthusiasm has waned and insiders have sold some stock.

What’s behind this trend?

Here are three possible reasons why big tech is facing a tough market.

Some disappointing earnings reports have increased investor skepticism and decreased investor confidence. For example, both Alphabet and Tesla reported slower sales growth and declining profitability. The high valuation for these stocks is tied to producing exceptional growth.

Anything less leads to sharp pullbacks.

Next, market sentiment seems to be rotating to smaller and international companies as well as value stocks. This includes Explorer blue-chip dominating stocks such as Unilever (UL), up 8.6% this past week.

The Russell 2000 index, which tracks small-cap stocks, has come alive by nearly 10% in the same period that large-cap tech stocks have pulled back.

Finally, there is rising political uncertainty at home and overseas coupled with more skepticism regarding the AI narrative running into what many now see as inflated stock valuations.

The above cocktail should lead you to make some adjustments to your portfolio but do so in an incremental manner. History shows that short-term market movements are random, but the long-term direction is up. We should have confidence in the upward climb over time as America, for all its challenges, remains the premier place to invest.

Just this week, Singapore’s sovereign wealth fund Temasek announced plans to invest $30 billion in the U.S. over five years as it trends cautious on China. Temasek’s investments in North and South America surpassed China for the first time in at least a decade this year. Temasek has grown its U.S. assets fivefold in the past decade.

And as you can see in the graph below, Japan’s stock market surge this year has led to it reaching rough parity with China.

New Recommendation

iShares MSCI India Small-Cap ETF (SMIN)

India presents us with some difficulties since it is persistently an expensive market with a very limited number of companies trading on U.S. exchanges.

The most well-known names are particularly expensive from a valuation point of view. Nevertheless, for several reasons, India is too strong to be ignored, and so today, I recommend a way to leapfrog some of these concerns.

India’s economy is firing on all cylinders. In the first quarter, it grew at an impressive 7.8% year over year - the fastest among major economies. The Asian Development Bank projects this growth will continue into 2025.

This top-line economic growth is leading to some impressive corporate profits.

The country’s manufacturing sector, fueled by overseas efforts to diversify away from China, has led to an investment boom. Southeast Asia, India, and Japan have been the winners as China’s star has lost some luster with investors.

Then there is India’s potential growth advantage due to a youthful population with a median age of 28.6 compared to China’s 39.5. This demographic dividend holds the potential of long-lasting consumer spending and a dynamic youthful workforce to power India’s companies ahead.

These are just some of the reasons India is increasingly the choice for overseas investors, leading to the country’s weighting in market indexes growing along with its geo-political heft.

The recent MSCI benchmark emerging markets index rebalancing saw India’s weighting increase to around 18%, up from just 8% in 2020 while China’s weighting has declined to 27% from 40%.

Whether India’s momentum will continue is an open question as it faces significant challenges in infrastructure, education, and food security. But investors have made a clear turn to India.

The best move right now would be a leapfrog approach with an exchange-traded fund (ETF) focused on India’s smaller companies.

I recommend the iShares MSCI India Small-Cap ETF (SMIN).

This is a $960 million fund that holds a basket of about 500 small-cap India stocks - many of which Western investors have never heard of since they are solely listed on domestic exchanges.

The fund isn’t overly costly at 0.79% in annual expenses. It is nicely diversified with the top ten stocks accounting for just 12% of assets. The lead sector is industrials at 25%, followed by finance at 15%, consumer goods at 14%, basic materials at 13% and healthcare at 10%.

With this ETF in place, I’ll be alert to adding some of this rising country’s stocks on any pullback.

BUY A HALF

Explorer Weekly Stock Commentary

Centrus Energy (LEU) shares were up almost 3% this week, and the company will report earnings after the close on August 6^th. Centrus recently received permission to import some Russian uranium which will enable the company to more fully process and supply essential nuclear fuel and services for the nuclear power industry. The emergence of new and safer nuclear power technology is a major Explorer theme. Buy a Half

Cloudflare (NET) shares edged up this week in anticipation of earnings which are expected out later today. This leading cyber security company powers 80% of websites and blocks billions of threats every day for its expansive client list. Buy a Half

Neo Performance (NOPMF) shares were off marginally for the second week in a row after previously demonstrating some relative performance. Neo is a key player in rare earths processing and some critical metal prices are poised to turn upward. Neo remains a good-value real asset stock due to its strategic importance, ample cash position, and low debt. Buy a Half

NIO (NIO) shares were up this week as China announced new EV subsidies and the company seeks to reinvigorate its stock in a competitive market. NIO designs and manufactures premium smart electric vehicles and is known for its styling and next-generation technologies such as battery-swapping charging solutions. This is an aggressive stock recommendation, so we need to watch NIO’s cash burn even though it has a sizable $6 billion cash position. Buy a Half

Novo Nordisk (NVO) shares were steady this week and, although the potential market is huge and the stock is up about 30% so far this year, we were right to take partial profits earlier this year. Its weight-loss drugs have a long tail, but we need to keep in mind that it is an expensive stock trading at 16 times sales, 40 times book value, and 38 times forward earnings. Hold a Half

Sea Limited (SE) shares were largely unchanged as we look forward to earnings on August 13^th. This will be an important date as we look for confirmation that the company’s profitability is trending upwards and demonstrates some consistency since it has missed earnings expectations two of the last four quarters. The stock is up 62% so far in 2024. Buy a Half

Super Micro Computer (SMCI) shares were up 5% yesterday as the stock broke 700 and the stock is also trading up in aftermarkets. Supermicro has been buoyed by accelerating spending on AI data centers and the company will report earnings on August 6^th. We have taken some profits, so I’m keeping this a hold for now as revenue expectations for the coming quarter are quite high. This is an aggressive stock at the heart of the AI boom. Hold a Half

Explorer Dominator Blue-Chip Recommendations - More Buy and Hold

International Business Machines (IBM) shares were up 4.4% as the company is getting more attention as a quiet giant in artificial intelligence (AI). IBM has consistently led in AI research, with numerous AI patents and pioneering technologies in machine learning, natural language processing, and AI-driven analytics. In fact, the company filed for more AI-related patents than any other company in 2023. IBM’s book of business for AI has grown to more than two billion dollars since the launch of Watsonx and is a counterweight to more volatile tech growth stocks. Finally, IBM shares trade at just 2.8 times sales or 14 times free cash flow. Buy a Half

Unilever (UL) shares jumped 8.6% after reporting comparable sales growth up 3.9% in the second quarter. Unilever’s operating margins were also up, and the company also raised its dividend by 3% as it began a 1.5 billion euro share buyback program. This company is a quality, long-term global consumer play with significant exposure to emerging consumer growth markets. Buy a Half

Visa (V) shares rebounded 4.5% this week after recently reporting a quarter with net revenue up 10% to $8.9 billion and net income surging 17% to $4.9 billion, or $2.42 per share. According to research by PwC, global cashless payment volumes are projected to grow by more than 60% from 2025 to 2030. Visa’s global network means it should benefit as cash-based emerging markets adopt debit and credit payments over the coming years. In more developed countries, IBM is embracing new payment approaches such as cryptocurrency and digital wallets which should help it maintain market share. Buy a Half

Watch List - past recommended stocks that I still like and keep an eye on

BYD (BYDDY), ConocoPhillips (COP), Franco-Nevada (FNV)

Explorer ETF/Fund Positions

Aberdeen Asia-Pacific Income Fund (FAX) is a closed-end fixed-income mutual fund launched and managed by Aberdeen Standard Investments (Asia) Limited in Singapore. Buy a Half

Grayscale Bitcoin Trust (GBTC) offers investors a way to track very closely to the day-to-day or “spot” movement of bitcoin prices. For aggressive investors comfortable with volatility. Buy a Small Allocation

JPMorgan Equity Premium Income ETF (JEPI) offers double-digit yield coming from both option premiums and dividends using a value-focused strategy. Buy a Full

Morgan Stanley China A Share Fund (CAF) offers exposure to a basket of the largest Chinese-listed stocks. Buy a Half

WisdomTree Emerging Markets High Dividend Fund (DEM) offers a high dividend yield and some of the highest-quality emerging market stocks. Buy a Half

WisdomTree’s Japan Hedged Equity ETF (DXJ) offers exposure to a broad basket of dividend-rich Japanese stocks hedging for yen currency fluctuations. Buy a Full Position

Model Portfolio

ETFs

Explorer Stocks Summary

Brief company summaries that will not change week to week.

Watch List: BYD (BYDDY) switched to producing only all-electric battery vehicles (BEVs) and plug-in hybrid electric vehicles (PHEVs). The company also manufactures and supplies EV batteries, including to Tesla, and makes its own chips. This is vertical integration that would make Henry Ford proud. BYD is in a strong position to be one of, if not the leader of the EV revolution in terms of size, scale, and growth.

Centrus Energy (LEU), based in Bethesda, Maryland, supplies nuclear fuel and services for the nuclear power industry in the United States, Japan, and Europe. Centrus Energy is building an enrichment facility in Ohio and would be very likely to benefit especially if federal funding moves forward to support this and other nuclear projects. I believe Centrus stock will benefit from increasing demand for its services, and that downside risk is low while upside potential is significant.

Cloudflare (NET) is both an aggressive and dominator recommendation offering products and services in four cutting-edge fields: cloud computing, AI, cybersecurity, and edge computing. Its global reach is breathtaking as 20% of all web traffic runs through Cloudflare’s network and over 95% of internet users from 180 countries worldwide access the company’s services each day. And it reaches these users within 50 milliseconds. The firm’s client list includes more than 30% of Fortune 1000 companies and the ability to efficiently move and connect data – from where it is located to where it is needed (edge computing) – is a massive business opportunity in which Cloudflare already excels.

Watch List: ConocoPhillips (COP) is a global energy industry giant and one of the largest independent exploration and production (E&P) companies in the world, as measured by production levels and proved reserves. The company, founded in 1917 and based in Houston, has operations in 13 countries, although almost half the company’s production is derived from U.S. sources.

Watch List: Franco-Nevada (FNV) is a company with more than half of its revenue coming from gold, but it also offers exposure to platinum, silver, and oil and gas. Franco-Nevada’s focus on royalties and streaming reduces risk and enables it to sidestep the huge capital costs that impact traditional miners. It enjoys cash flow and profits as its mining partners finance and complete exploration and expansion projects. That cash flow enables it to invest in new deals, pay a dividend, and operate debt free. Franco-Nevada has increased its dividend each year since its IPO in 2008.

International Business Machines (IBM) is a blue-chip artificial intelligence (AI) and India play with a nice dividend yield. Known as “Big Blue,” IBM now primarily helps businesses and governments manage their information technology in the cloud era. The stock sells at a discount to the S&P 500 multiple and the information technology sector’s forward earnings multiple. IBM has paid a dividend every quarter since 1916 and has had 28 consecutive years of dividend increases.

Neo Performance (NOPMF) manufactures the building blocks of permanent magnets and powers many modern of these technologies and advanced industrial materials. These include magnetic powders and magnets, specialty chemicals, metals, and alloys - all using rare earths and minerals critical to permanent magnets. Neo has a global platform that includes nine manufacturing facilities located in China, the United States, Germany, Canada, Estonia, and Thailand, as well as one dedicated research and development center in Singapore.

Neo has ample cash and very low debt levels. The stock also offers us an excellent hedge on China/Taiwan risk, a forward 4.8% dividend yield, and incentives are aligned with about 20% of the outstanding stock held by management.

NIO (NIO), founded in 2014, designs and manufactures premium smart electric vehicle as well as innovations in next-generation technologies including assisted and intelligent driving, digital technologies, electric powertrains, and batteries. Nio’s stock seems to be poised for a rebound even though the macro picture for China is not encouraging. Nio has a premium brand image, which will differentiate it from its mass-market competitors and its advancing battery technology and charging solutions will ease range anxiety on electric cars. Nio stock is clearly an undervalued EV player at these price levels, but we need to accept that this is an aggressive stock recommendation.

Novo Nordisk (NVO) specializes in treatments for diabetes, hemophilia, and obesity. The company supplies half of the world’s insulin, and its diabetes care products are used by over 34 million people today. Novo highlights that more than 750 million people are currently living with obesity and that this is up a multiple of 3X since 1975. In summary, based on sizable and growing demand for its blockbuster weight-loss drugs, Ozempic and Wegovy, this well managed, highly profitable company with an excellent growth profile and potential to develop new products has limited risk.

Sea Limited (SE) has three core businesses: 1) digital gaming/entertainment, 2) e-commerce, and 3) digital payments and financial services, known as Garena, Shopee, and SeaMoney, respectively. Garena is a leading global online games developer and publisher. Shopee is the largest e-commerce platform in Southeast Asia and Taiwan. SeaMoney is a leading digital payments and financial services provider in Southeast Asia. Some of you may recall this stock when it was an Explorer recommendation in the fall of 2019 at around $30 and became more than a 10-bagger to its 2021 high.

Super Micro Computer (SMCI), commonly known as Supermicro, manufactures enterprise computer server hardware for cloud computing, artificial intelligence, data storage and telecommunications. Super Micro stock looks relatively inexpensive right now for the growth that it has been delivering. The company trades at just two times sales. Super Micro has two larger rivals, Dell (DELL) and Hewlett Packard (HPE), but it is forecast to grow five to 10 times faster. Furthermore, both Dell and HPE have relatively high debt whereas Super Micro has a net positive cash position. This is an aggressive pick in a sector experiencing extraordinary growth.

Unilever (UL) is a dominant consumer goods giant with a trove of 400 recognizable brands in its diversified portfolio – from Vaseline to Dove – that it sells in over 190 countries. However, 30 “power brands” account for almost 75% of Unilever’s total sales. It is a steady, stable stock for an uncertain environment and for a change, its stock is selling at a rare discount – down about 9% from all-time highs and at just over two times sales. Two other reasons I like Unilever are that 78% of its sales are outside North America and almost 60% are from emerging markets that offer higher consumer sales potential due to better demographics.

Visa (V) doesn’t extend credit but provides the plumbing for financial payments and communications throughout the world. Visa’s financial infrastructure also underpins much of the world’s commerce. The duopoly between Visa and Mastercard is often referred to as one of the best businesses in the world, with insurmountable moats, low operating costs, and plenty of opportunities for unlocking additional value. Visa currently trades at a discount to its archrival MasterCard. This leaves it much better poised to outperform the latter going forward.

The next Cabot Explorer issue will be published on August 15, 2024.

Copyright © 2024. All rights reserved. Copying or electronic transmission of this information without permission is a violation of copyright law. For the protection of our subscribers, copyright violations will result in immediate termination of all subscriptions without refund. Disclosures: Cabot Wealth Network exists to serve you, our readers. We derive 100% of our revenue, or close to it, from selling subscriptions to our publications. Neither Cabot Wealth Network nor our employees are compensated in any way by the companies whose stocks we recommend or providers of associated financial services. Employees of Cabot Wealth Network may own some of the stocks recommended by our advisory services. Disclaimer: Sources of information are believed to be reliable but they are not guaranteed to be complete or error-free. Recommendations, opinions or suggestions are given with the understanding that subscribers acting on information assume all risks involved. Buy/Sell Recommendations: are made in regular issues, updates, or alerts by email and on the private subscriber website. Subscribers agree to adhere to all terms and conditions which can be found on CabotWealth.com and are subject to change. Violations will result in termination of all subscriptions without refund in addition to any civil and criminal penalties available under the law.