The action of the last couple of days has been a smack in the face for all investors, U.S. and emerging markets alike. As always, the Cabot growth disciplines tell us not to panic, but also not just to sit there and let the market take away your money. While we don’t have any changes to the portfolio tonight, this issue of Cabot Emerging Markets Investor shows a distinctly defensive tone, with a very heavy cash position and just two stocks rated Buy. We also have a new stock this week that’s perfectly suited to conditions. It’s a commodity play with a generous dividend, attractive valuation and a simple story. Read on for all the details.
Cabot Emerging Markets Investor 669
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Cabot Emerging Markets Timer
The Emerging Markets Timer is our disciplined method for staying on the right side of the emerging markets. The Timer is bullish when the index is above the lower of its two moving averages and that moving average is trending up.
The nascent buy signal from the Emerging Markets Timer is at the moment of truth after this week’s selling. The iShares EM Fund (EEM) did enough to get above its lower (25-day) moving average, and the 25-day line did perk up a bit, causing a technical sell signal. But EEM has again been hit with selling, causing the fund to fall back below its line.
Taking a step back, the intermediate-term trend is effectively neutral-to-down at this point—EEM hasn’t been able to mount a sustained rally, but it’s also been mostly range bound since early August. Keep your eyes open, but right here it’s best to stay defensive while we wait for the buyers to show they’ve taken control.
Using Your Different Brains
No matter what investment style you prefer, what markets you target, your risk tolerance or your time horizon, successful investing requires you to think differently. And I don’t mean just differently from your fellow investors; you have to be able to think differently from yourself.
Right now, for instance, you need to be using one part of your investing brain to appreciate and take advantage of the long bull run in U.S. growth stocks. You also need to be worried about the signs that the U.S. rally may be showing signs of weakness.
But your growth strategy shouldn’t spill over into your income holdings or your long-term blue chip positions. And the 10% or so that you have allocated to emerging market stocks should be sitting about 70% in cash right now as we wait (mostly) calmly, for Chinese stocks (or Brazilian or Indian or whatever) to put in a durable bottoming formation and get ready for the next upmove.
The important thing is to avoid letting emerging market contagion push you into excessive defensiveness in your U.S. holdings and, conversely, not letting U.S. bullishness lead you into unwise optimism about Chinese (and other EM) stocks.
Don’t let your growth hand know what your value hand is doing.
It’s always nice to have a hopeful story to report, and the news that Tencent Music would be staging a U.S IPO is definitely in that category. Tencent Music is a very big deal, the result of Tencent Holdings’ taking over China Music Corp. in 2016 and combining it with its own streaming business.
Tencent’s roster of 800 million unique monthly active users (MAU) creates one of the biggest built-in audiences for any streaming service anywhere in the world. For instance, while Spotify boasted 157 million MAU at the end of 2017 and 180 million at the end of the second quarter (including 83 million paying subscribers), Tencent Music says it has 644 million MAU, of whom 23 million are paying customers. And while Chinese users are notoriously reluctant to buy what they can get for free, the process of converting more of its base to paying customers gives Tencent Music huge potential.
Like Spotify, Tencent Music allows anyone to stream content, but only users who pay can avoid the ads that punctuate the music. But the sheer scale of Tencent Music’s audience (plus its greater emphasis on the social media side of music and live events) makes it look like an enormous opportunity.
Preliminary estimates have placed the value of the Tencent Music IPO at around $25 billion, which is a very big deal. Only Alibaba ($169 billion), Facebook ($81 billion), Spotify ($27 billion) and JD.com ($26 billion) have been above that level.
Parent company Tencent Holdings has been having a rough go of it this year, declining along with the broad Chinese ADR market. And it may be that the general downtrend in EM stocks will put a slight damper on Tencent Music’s coming-out party. But a story this big will undoubtedly find a regiment of institutional investors ready to participate. It shouldn’t take long.
Another recent Chinese IPO—NIO Inc. (NIO), the Chinese electric car maker—has certainly seen some skepticism since it came public on September 12. The stock, which traded from its opening at 6 to as high as 13.8 a few days later, has now glided back to its opening price. That may be another bargain to keep an eye on if the company can produce a quarter or two of good growth numbers.
Featured Stock
Cheap and Strong
Companhia Vale do Rio Doce (VALE)
Companhia Vale do Rio Doce (literally the Doce River Valley Company, but just Vale to its friends) is a big Brazilian iron miner. The company was founded in 1942, and has a huge footprint in the Brazilian economy, including power generation, ore transportation and shipping, production of base metals and coal and other infrastructure aspects.
But the story is really iron ore, of which Vale is the largest producer in the world and also, it claims, the highest quality producer. The company was privatized in the late 1990s after more than 50 years as a state-owned enterprise.
In the first quarter, Vale got 73% of its revenue from the sales of iron ores and pellets, with 42% of that revenue coming from China. Sales of nickel (of which it’s also the world’s largest miner) made up just 9%, with other products like copper and coal making up the rest.
So Vale is basically an iron ore and iron pellet story, with China by far the largest customer. (Europe was the second-largest market with 17% of Q1 revenue.)
The question is: What’s been happening that has investors looking at Vale after the company’s stock has traded sideways through most of 2018 until it blasted off in September?
The answer is that the global steel supply is down, and the companies working to make up the shortfall are willing to pay a premium for high quality ore. Vale’s 65% iron ore commanded a premium of $16 a ton in Q1, which increased to $20 a ton in Q2. The second quarter also featured a dramatic truck drivers’ strike in Brazil, and Vale’s ability to adjust mining, milling and transportation methods to get its iron ore and pellets to market produced record sales.
Vale experienced revenue drops of 20% in 2014 and 32% in 2015, but has bounced back. 2016 sales were up 7% and 2017 revenue was up 24%. Sales this year have come in at 1% in Q1 and 19% in Q2. After a couple of slightly weaker quarters, Q2 earnings popped higher by 150%. Analysts (who don’t seem to have a very firm grasp on things) are looking for earnings to rise by just 1% this year (!?) and by 20% next year.
VALE made a monster run from 2003 to early 2008, soaring from 2 to 44 before the Great Recession spiked its guns. From its correction low at 9 in late 2008, VALE made it back to 37 at the beginning of 2011. That’s when the wheels came off, dropping the stock to 2 in early 2016. VALE made it back to the mid-teens earlier this year, and broke out to touch 16 just this week. There’s still solid support at 12, which has been durable all year.
VALE isn’t likely to be a skyrocket stock, but I think it will be a good addition to the portfolio right now. Its advantages are: 1) a dividend that sports a 3.4% forward yield, 2) a new company stock repurchase program that is authorized to buy back $1 billion of stock over the next year, and 3) a dirt cheap 8.9 forward P/E ratio.
The bottom line is that VALE is solid, cheap and will pay us while we wait for hotter emerging market stocks to consolidate and recover. With a long-term uptrend and a substantial flat base since the start of 2018, I’m going to recommend taking a full position in VALE. BUY.
Companhia Vale do Rio Doce (VALE)
Prais de Botafogo 186
Offices 701–1901 Botafogo
Rio de Janeiro, RJ22250-145 Brazil
http://www.vale.com
55 21 3485 5000
Model Portfolio
Invested 40% Cash 60%
Updates
It may be that the Fed’s recent actions have increased the attractiveness of bonds versus stocks. But whatever the cause, emerging market stocks have taken it on the chin over the last two days, pulling both the iShares EM Fund and the China Golden Dragon Fund decisively into the bearish camp.
It’s not a dire situation, as both ETFs are just back to their lows from September, but it does interrupt what looked like a promising upmove. Our cash position is plenty high enough to weather the storm, but you should be paying close attention to your personal loss limits.
We have no changes to the portfolio tonight.
Alibaba (BABA) has pulled back in parallel with the broad Chinese ADR universe. Investors have been getting used to the idea of Jack Ma leaving the helm at Alibaba, but the company will remain extremely active in business development, M&A and strategic investments. Goldman Sachs just reiterated its Buy rating on BABA. And even though our position is on Hold, it’s nice to have the supporting sentiment. HOLD.
Baidu (BIDU) has now put in a triple bottom that dates back to August. News that the company was expanding into the TV box market didn’t seem to impress investors, but it’s a sound move into a lucrative niche. BIDU will stay on the Watch list, but if it can bounce again at 208, that would be a positive sign. WATCH.
BeiGene (BGNE) continues to trade in a tightening range, with both lower highs and higher lows in August and September. The longer BGNE can trade sideways, the higher the probability of a powerful move once the market pressure comes off the stock. The company just keeps issuing results from clinical trials of its anti-cancer drugs, which should provide the fuel for a rally eventually. As long as the stock sticks above 160, we’re okay with small purchases on dips. BUY A HALF.
Bilibili (BILI) dipped as low as 9 in August, so the general trend is definitely up. And even with today’s selling, BILI is still on top of its 25-day moving average. Yesterday’s news that Bilibili was getting a major infusion of cash ($318 million) from Tencent Holdings pushed the stop briefly above 15, but today’s general weakness dropped it back below 14. There’s plenty of interest here, we just have to wait for the market to get back on our side. WATCH.
Ecopetrol (EC) has given back just a point of its September move from 22 to 28. The oil price story is a strong one, and as long as prices keep their gains, EC will likely keep its own gains. You can buy a half position here. BUY A HALF.
Huya Inc. (HUYA) has fallen through a couple of attempted support levels, slipping under 21 in today’s energetic selling. The move is most likely just in step with the market, but there may be a little investor skepticism about the company’s video-game watching business model. Amazon Twitch was recently denied access to the Chinese market, and it’s hard to see whether that’s likely a good protection for Huya or a warning that the government doesn’t much care for the business. We’ll wait for the market to sort it out before we make a move. WATCH.
iQIYI (IQ), our third recent IPO, has been holding up well, staying on top of the support at 25 that it established in August and reinforced in September. The next week or so will likely set the tone for IQ until we get a new quarterly report or other substantial chunk of data. But for now, IQ is holding up much better than the broad market, and you can continue to hold your half position. HOLD A HALF.
RYB Education (RYB) is sticking tightly to its narrow trading range, which makes it a source of relative strength. If you have plenty of cash on the sidelines, you can take a small position here, as this is now the strongest Chinese education stock. It also just picked up an upgrade from a Morgan Stanley analyst on Tuesday. BUY A HALF.
WNS Holdings (WNS) just yeeps plowing sideways, which is a sign of relative strength in a squish market. The company just announced that it will release its fiscal Q2 results on October 25 before U.S. markets open. That should stir the pot enough to get WNS going. WATCH.
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Send questions or comments to paul@cabotwealth.com.
Cabot Emerging Markets Investor • 176 North Street, Salem, MA 01970 • www.cabotwealth.com
All Cabot Emerging Markets Investor buy and sell recommendations are made in issues or updates and posted on the Cabot subscribers’ website. Sell recommendations may also be sent to subscribers as special alerts via email. To calculate the performance of the hypothetical portfolio, Cabot “buys” and “sells” at the midpoint of the high and low prices of the stock on the day following the recommendation. Cabot’s policy is to sell any stock that shows a loss of 20% in a bull market (15% in a bear market) from our original buy price, calculated using the current closing (not intra-day) price. Subscribers should apply loss limits based on their own personal purchase prices.
THE NEXT CABOT EMERGING MARKETS INVESTOR ISSUE IS SCHEDULED FOR October 18, 2018
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Cabot Emerging Markets Investor is published by Cabot Wealth Network, an independent publisher of investment advice since 1970. Neither Cabot Wealth Network, nor our employees, are compensated in any way by the companies whose stocks we recommend. Sources of information are believed to be reliable, but they are in no way guaranteed to be complete or without error. Recommendations, opinions or suggestions are given with the understanding that subscribers acting on information assume all risks involved. © Cabot Wealth Network 2018. Copying and/or electronic transmission of this report is a violation of the copyright law. For the protection of our subscribers, if copyright laws are violated, the subscription will be terminated. To subscribe or for information on our privacy policy, visit www.cabotwealth.com, write to support@cabotwealth.com or call 978-745-5532.
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