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Cabot Emerging Markets Investor 652

Emerging market stocks corrected sharply along with U.S. stocks today, dropping back to December levels and closing decisively below the MSCI EM ETF’s 25- and 50-day moving averages. We didn’t really need that kind of technical signal to tell us that all growth stocks were falling off the end of the dock, but it’s good to get a formal notice.

Cabot Emerging Markets Investor 652

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Cabot Emerging Markets Timer

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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 plunge of the past couple of weeks has turned our Emerging Markets Timer negative, telling us to practice caution. Like everything else, the iShares EM Fund (EEM) had a huge run-up for most of January but has corrected sharply in recent days, plunging as much as 11.5%. Today is decisively moved below its 50-day line, indicating that the intermediate-term trend is effectively neutral.

We’re not panicking, but following the system, it’s prudent to pare back—selling some losers, taking partial profits and holding some cash makes sense as we wait for the market to find solid support. We are, however, holding our resilient performers, a few of which are likely to help lead the next market upturn.

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Damage Control

Well, it’s not like we weren’t warned that this could happen. Stocks stayed in rally mode throughout 2017, with a few flat patches and minor pullbacks to keep things interesting. There was even a two-week sideways run in December that looked like a cooling-off period.

But when trading resumed in January, stocks took off again like a bottle rocket. And while we knew (and said) that January’s rally wasn’t sustainable, we didn’t know when it would end, or what the market would do when it did.

Now we know when, at least. The major indexes took a major hit last Friday and went into freefall on Monday, with the Dow Industrials losing 1,175 points in one day, which was the all-time record drop in market history. (The previous record was 778 points in the middle of the 2008 financial crisis crash.)

The iShares MSCI EM ETF (EEM), which had been vamping in place after hitting a new all-time high at 52 on January 26, ran a parallel correction on Friday and Monday, with trading volume spiking from 72 million on February 1 to 117 million on February 2 (Friday) and 151 million on February 5. In all, EEM corrected by 9% from January 26 to February 5 before rebounding by almost 4% on Tuesday.

The Blame Game for the market’s painful pullback quickly became a major obsession with financial talking heads in print and on TV. The usual suspects were trotted out: interest rates, panic selling, a crowded short volatility trade, complacency on the part of investors and (for New England investors), the Patriots’ loss in the Super Bowl.

But whatever part particular influences may have played, the general explanation of the market’s February Funk was that buyers had been beating sellers into submission for entirely too long. The market is always a battle between optimists (buyers) and pessimists (sellers), with buyers pretty much owning the long-term trend.

But the sellers never go away, and when markets get to the point that enough investors stop believing in the likelihood of a correction, that’s when the sellers strike. We talk all the time about a stock that has corrected until it has shaken out the weak hands. And what we have had was a market filled to capacity with weak hands.

So it really doesn’t matter which of the pieces of information set off the correction. The fact is that markets need sellers in the same way that a deer herd needs wolves.

In the long run, the prospects for both U.S. and emerging market stocks look good. The U.S. and Chinese economies are expected to expand strongly in 2018. The U.S. tax reform will improve earnings for lots of companies. There are still plenty of icebergs to navigate around (Brexit, North Korea, Russia), but that’s always the case.

Our job is to regulate our exposure and cash positions to stay in step with the market’s main trend, to manage our stocks to minimize losses and keep finding the strongest stocks to either buy or put on our watch list. It will be interesting to see how long it takes the market to recover, re-base and get moving again. History is a good advisor for the long run, but doesn’t provide great short-term guidance. We’ll have to do that ourselves.

Featured Stock

The Third Way to Retail
Vipshop Holdings (VIPS)

The Chinese retail industry is an enormous playground, with a few giants and many smaller aspirants. Alibaba (market cap $460 billion) is the biggest name, a company that distinguishes itself by offering a marketplace where others can buy and sell, but not owning any merchandise itself. JD.com. (market cap $61.8 billion) is a more traditional online retailer, with a string of warehouses and an extensive delivery infrastructure that covers virtually all of China.

Many investors think that these two giants are pretty much the only choices in Chinese retail. But today, we’re looking at Vipshop Holdings (VIPS, market cap $10.8 billion), a company that’s finding a way to prosper in the shadow of the giants.

Vipshop’s big thing is big discounts and limited quantities, in other words, flash sales. The company focuses on name-brand apparel, shoes and handbags, but will sell almost anything that it can offer at a great price. The company has cultivated relationships with over 20,000 brands, including many top name brands. And manufacturers see Vipshop as a way to introduce new lines, promote styles and liquidate inventory. In the third quarter, the company added Diesel, Marc Jacobs, Sergio Rossi, Shanghai Tang and Peuterey to its list of brand partners.

Vipshop grew revenue by 33% in 2016 and by 23%, 28% and 28% from Q1 to Q3 2017. In its latest quarterly report, the company increased its number of active customers by 22%, up from 49.6 million at the end of Q3 2016 to 60.5 million in 2017. The company’s customer base skews young, and customer loyalty is high.

The company is still primarily a Chinese retailer, but that has been changing, with Vipshop increasing its warehouse space in Australia, France and the U.S. 98% of Vipshop’s merchandise was delivered through its proprietary last mile network, up from 90% a year earlier. Returns collected directly by Vipshop last mile staff increased from 50% a year earlier to 72% in Q3.

The company made headlines in December when it cut deals with JD.com and Tencent Holdings, both of which are looking for ways to gain traction in the battle with Alibaba. Their combined $863 million investment will leave Tencent with a 7% stake in Vipshop, with JD.com increasing its prior 2.5% equity position to 5.5%.

We will get a better read on how Vipshop’s business is developing when the company delivers its Q4 and full-year report next Monday (February 12) after the market closes. Analysts are looking for $3.7 billion in revenue and twenty cents per share in earnings.

VIPS made a huge run from the middle of 2012 to April 2015, then started a long decline, falling to 10 in early 2016 and trading sideways through May 2017, when it started another correction. The stock rebounded with unusual sharpness in December, gapping up from 8.4 on December 15 to 12.6 on December 18. Volume was immense. The good news kicked VIPS into a rally that ran to near 18 on January 26. The general weakness in Chinese stocks that began on January 29 put a dent in VIPS, but didn’t break it. The stock dipped just to its 25-day moving average just under 15, then perked back up to 16, defying the market’s weakness.

While it’s good to see a stock that’s outperforming the market, the state of the market itself is such that we’re not doing any buying right now. And that’s particularly true when a company is just two days away from its quarterly and annual report. We will put VIPS on our Watch list, and could easily take a small position if the reaction from investors on Tuesday is positive. WATCH.

Vipshop Holdings (VIPS 15)
No. 20 Huahai Street
Liwan District
Guangzhou 510370
China
86 20 2233 0000
www.vipshop.com

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Model Portfolio

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Invested 75% Cash 25%

Updates

Swift market declines are never fun, but after a heady run, some sort of rug-pulling event was overdue. Now that it’s here, the key, as always, will be staying in gear step the market and individual stocks. After today’s action, the intermediate-term trend is pointed down, and we’ve seen a few stocks show abnormal action.

Overall, we’re treating this as an intermediate-term correction until proven otherwise. That means cutting back on new buying, cutting loose losers and laggards, but also holding our winners and resilient performers because some of them will likely lead the next market upturn.

We did some selling on a Special Bulletin on Monday, we sold two half positions (WUBA and BIDU). And tonight, we’re raising some more cash by selling our remaining shares of SUPV, while selling half in both Tencent and YY. If we have any further changes in the days ahead, we’ll let you know.

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58.com (WUBA) was sold in Monday’s Special Bulletin, not just because it’s taken a hit recently, but because the recent downmove means it hasn’t made much net progress since August of last year. We think there will be better stocks to own when the buyers retake control of the market. SOLD.

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Alibaba (BABA) is looking ragged, though even after today’s fall, the stock is “only” back into the base it was etching during Q4 of last year. Fundamentally, we don’t think anything has changed, either (analysts still see 30%-ish earnings growth going forward), so we’re content to hold on given our good-sized profit. That said, we are going to be keeping an eye on the low- to mid-160s, which is near the 200-day moving average—a break of that would call into question BABA’s longer-term trend. HOLD.

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Autohome’s (ATHM) is still north of its 50-day line, which is relatively rare for growth stocks right now. We don’t advise buying much in this environment, but given ATHM’s reasonable pullback, we’re OK nibbling here if you don’t own any. BUY.

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Baidu (BIDU) was also tossed out on Monday’s Special Bulletin. We sold half about a month ago, and given the stock’s action of late, are glad we’re out of the rest of our position. SOLD.

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China Lodging Group (HTHT) has taken a hit during the past three weeks, slipping about 20% back to its October highs. Fundamentally, the company continues to expand, with a newly-formed joint venture acquiring a company that operates many hotels in Beijing’s central business area. Even so, because of the market, we’re moving our half position to a Hold rating. HOLD A HALF.

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GDS Holdings (GDS) has pulled back with everything else in recent days, though it’s still hanging around its 25-day moving average, which is a solid show of resilience. The recent share offering could hang over the stock for a bit, but the trend is strongly up. You can nibble here if you’re not yet in. BUY.

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We sold half our shares in Grupo Supervielle (SUPV) a couple of weeks ago (booking partial profits on the way up), and tonight we’re going to sell the rest. The stock doesn’t look awful, but it’s come under distribution, and our worry is that the stock hasn’t had much of a pullback since it got going back in August around 18. It’s been a nice ride, but we’ll take the rest of our profit and hold the cash. SELL.

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Melco Resorts and Entertainment (MLCO) reported a good-not-great quarter this morning, with sales up 12%, EBITDA (cash flow) up 12% and earnings up 62%, but those figures were a bit shy of estimates. The company did bump up its dividend by 50% (new annual yield is around 1.9%), which is a plus, but the stock still sagged a bit on the news. We’ll move MLCO to a Hold rating and watch it’s progress closely. HOLD.

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Petrobras (PBR) could certainly fall further if the market remains weak, but we think the current dip to the 25-day line looks normal and buyable. And, big picture, the company’s turnaround story is very big. If you don’t own any, you can nibble here. BUY A HALF.

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TAL Education (TAL) is still holding most of its earnings gains from two weeks ago, which is encouraging given the market’s action. Analysts see earnings up 62% in the fiscal year that starts in March, and the growth opportunity for the company (education in China in general) remains huge. That said, we’ll let TAL tell its own story—if it falls through its 200-day line (near 27), it will be time to sell. Above that area, we advise holding a half-sized position and giving the stock a chance to resume its long-term uptrend. HOLD A HALF.

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Tencent Holdings (TCEHY) continues to make a ton of investments, with the latest being a stake in Wanda, China’s biggest mall developer. (JD.com was also in on the funding round.) Long-term, there’s plenty of growth ahead, but we don’t own the company—we own the stock. And on that front, we are a bit wary of TCEHY here given that shares have had a mostly uninterrupted run since the start of 2017. Thus, we’re going to sell half our shares tonight, with the goal of holding the rest for the longer-term with a loose stop (possibly in the mid- to upper-40s). If you own some, sell half, and hold the rest. SELL HALF, HOLD THE REST.

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Weibo (WB) is moving back to a Hold rating given the stock’s recent slippage and the market weakness. The stock does have support in the 110 area, so we’re willing to give it a little rope, but we’re not going to let any major loss develop. Earnings are due out February 13. HOLD.

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We’re also going to trim our position in YY Inc. (YY), selling half our shares after an excellent run in recent months. As with Tencent, YY’s recent pullback isn’t terribly abnormal, but the stock has dipped below its 50-day line for the first time since last April (!), during which the stock moved from 50 to as high as 143. Long story short, we’re taking partial profits and will hold the rest. SELL HALF, HOLD THE REST.


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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 February 22, 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 2017. 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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