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Cabot Emerging Markets Investor 653

Emerging market stocks have followed the lead of the major U.S. indexes by executing a V-shaped bounce from their January/February slump and most of our stocks are in good shape. We’re keeping an eye on Chinese New Year as an economic force and on the battle between Alibaba and Tencent/JD.com for leadership in the Chinese online retail race. And we have a high-flying Chinese biopharmaceutical company to fit into the portfolio.

Cabot Emerging Markets Investor 653

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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.


Back on Buy! Our Emerging Markets Timer has flashed a green light after a very impressive snapback rally—the iShares EM Fund (EEM) has recovered as much as 70% of its early-February drop and has been above its 50-day line (which is still trending up) for the past few days. That’s a sign the intermediate-term trend is pointed up.

Granted, this isn’t what we would consider a fantastic entry point—with market volatility still high, there’s clearly a chance EEM might get whipped around in the days ahead. Thus, we’re growing more bullish, but advise putting cash to work slowly to see if this rebound gains steam.

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A New Year and an Old Battle

The MSCI Emerging Markets ETF (EEM) took a serious blow to the head during the January 29–February 9 correction, falling 13.5% in just 10 trading days. That decline exceeded the 10% pullback required to meet the textbook definition of a correction and more than lived up to market-watchers’ fears.

And our portfolio felt it. We did some selling and pushed several stocks to Hold ratings based on their performance.

But EEM’s subsequent rebound has been quite remarkable. The ETF popped from 45 to 50 from February 9 to February 16 in a V-shaped recovery that totaled 11% before the recent pullback took a little of the shine off the rally.

As we noted in last week’s update, it would be more typical for a stock or an index to either stagger around sideways for a while or actually fell back to retest its lows—both patterns usually lead to sturdy bottoms. And that may yet happen as EEM continues its recovery.

Fortunately, our Cabot Emerging Market Timer is admirably simple: if EEM is above the lower of its 25- or 50-day moving averages and that average is headed up, we have a buy signal. We don’t second-guess the Timer no matter how much we anticipate what might happen. It’s human nature to wonder about what might happen tomorrow, and we gaze into the crystal ball as much as anyone. But we also follow the rules, which today tell us to put a little cash to work.

On a completely different topic, Chinese New Year is in full swing as China’s population celebrates the arrival of the Year of the Dog. This is an international story every year, with great pictures of fireworks, dancing dragons, red envelopes filled with money (well, red everything) and a few shots of traffic jams as nearly the entire country takes to the road for family reunions.
The U.S. doesn’t have anything to parallel the week-long Chinese New Year holiday. Chinese stock markets close for a few days (although not the whole week), ports and shipping slow to a standstill, every mode of travel is stretched to capacity and restaurants and shops are jammed. Along with National Day Golden Week (in October) and Singles Day (11/11), it’s a major economic event with effects felt around the world.

We also want to comment on the major competition underway in the Chinese retail sector. Unlike the U.S., where Amazon virtually owns online retail, China has a real battle going on. Alibaba, with a market cap of $491 billion and annual revenue of $33.3 billion, is the big dog. Alibaba’s business model, which is to provide a marketplace for buyers and sellers to meet up, lets the company do business without physically owning any merchandise. With no inventory, warehousing, fulfillment and delivery expenses, Alibaba’s after-tax profit margins are usually well above 30% (32.5% in Q4 after hitting 44.5% in Q3).

By contrast, JD.com is a more traditional retailer with a much smaller market cap ($68 billion), but bigger annual sales ($48.7 billion) and a more typical after-tax profit margin (2.6% in Q3) for retail. JD.com is expanding rapidly by building out warehouse capacity, delivery infrastructure and other capital-intensive projects, which requires skillful management to stay profitable.

But the list of combatants in the retail war includes many companies that have no direct exposure to selling stuff. Baidu, which is still the top online search company in China, and Tencent Holdings, which is best known for its popular WeChat instant messaging system, are frantically investing in and forming joint ventures with retail companies as they position themselves to resist becoming also-rans to Alibaba’s behemoth.
As far back as 2014, Baidu, Tencent and Wanda (a real-estate and movie theater chain group) announced an $814 million e-commerce joint venture to challenge Alibaba by promoting Tencent’s online payment system and leveraging Wanda’s media assets.

The campaign of investment hasn’t let up, with Tencent and JD.com now owning stakes in Vipshop Holdings of 7% and 5.5%, respectively, after an $863 million investment round in December. Tencent has turned its WeChat service into an online ecosystem that features games, payments and e-commerce, and is really the core of the counterforce to Alibaba. With a market cap of $561 billion and 26.2% after-tax profit margins, Tencent’s pockets are deep and the stakes are high.

This competition has generated a lot of energy in the Chinese online retail sector, lifting smaller companies and keeping the pace of new alliances high. It’s a good environment to be fishing in. Today, though, we’re revisiting a dynamic, young biotech firm that has huge potential.

Featured Stock

The Second Time Around: BeiGene (BGNE)

Revisiting a stock that you have owned and sold can be a humbling experience, but that shouldn’t stop you from considering it.

In February 2017, we bought BeiGene, a Chinese biopharmaceutical company focused on developing and commercializing molecularly targeted and immuno-oncology treatments for cancer. The company, with a market cap of $1.22 billion and revenue of just $6 million, had four candidate drugs in clinical trials, including one that was named a China National Priority project, and just a few months before had just gotten good news from clinical trials of BGB-3111. BeiGene had a limited partnership with Merck.

Unfortunately, we got shaken out of BGNE before the real good news started to arrive. Now we’re back for a second look.

BeiGene is now a commercial-stage Chinese company with a market cap of $8.2 billion and revenue of $220 million. In July 2017, the company acquired a much stronger corporate sponsor in Celgene, the drug giant that owns a 5.6% stake in BeiGene. As part of that deal, Celgene acquired the rights to develop and commercialize BeiGene’s PD-1 inhibitor, BGB-A317, in markets outside Asia in patients with solid tumor cancers. BeiGene retained the rights to develop BGB-A317 for use against hematological cancers and received $263 million in cash with nearly $1 billion in potential payments if various milestones are attained.

Then in September came positive Phase I clinical trial results that confirmed BGB-A317’s anti-tumor activity and patient tolerance. In a separate deal, Celgene gave BeiGene exclusive rights to commercialize Abraxane, Revlimid and Vidaza, three of Celgene’s therapies that are already approved in China. BeiGene got $413 million in licensing fees and other investments from Celgene in the last half of 2017 and conducted a very successful secondary stock offering in January. It’s worth noting that investors responded positively to the offering, bidding the price up, which is unusual, as secondary offerings are usually considered dilutive to value. With the cash now on hand and the revenue from Celgene’s profitable drugs, BeiGene should be able to fund its development activities for a couple of years at least.

BGNE made fitful progress from its IPO in February 2016 until it blasted off in the first week of July 2017, when it ripped from 45 to 70. Another rally in September pushed BGNE above 100. The stock pulled back to support at 80 in October and November, then rose steadily through the middle of January, when it got another burst of energy, soaring to 140 before negative market action dropped it back to support at 122. BGNE started a new rally on February 14 and briefly topped 160 before pulling back slightly.

With the Cabot Emerging Markets Timer positive, we will add a half position in BGNE to the portfolio tomorrow. BUY A HALF.

BeiGene (BGNE 156)
94 Solaris Avenue
Camana Bay
George Town KY1-1108
Cayman Islands
345-949-4123
www.beigene.com

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Model Portfolio

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Invested 80% Cash 20%

Updates

It’s been a very interesting past few weeks to say the least, with emerging market stocks plunging along with everything else during the first couple of weeks of February before storming back the week after. Recent days have seen choppy action and not a lot of price movement.

Overall, though, the powerful rebound has turned our Emerging Markets Timer positive, so we’re taking a constructive view of the market. That said, while we always go with the evidence and thus are turning more positive, we think it’s also prudent to go slow and let the market “pull” us into a more heavily invested position by continued bullish action. Tonight we’re mostly standing pat, but we are selling MLCO due to a weak bounce and the fact that our other stocks are acting much better.

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Alibaba (BABA) has popped nicely in recent days, moving back above its 25-day moving average. The company continues its investment spree; it recently bought a 15% stake in Chinese furniture operation Easyhome (which has more than 200 stores and nearly $10 billion in revenue) for $851 million. But at this point, we’re mostly focused on the stock—it’s been mostly chopping sideways since early November, which looks normal after its big multi-month advance. HOLD.

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Autohome (ATHM) only dipped to its 50-day line during the market’s selling storm and has bounced back to its old high, a great sign of strength. Earnings are due on March 7, which will be key, but so far we’re very encouraged by the action, and of course, we think the story is top-notch. You can grab some shares here or on dips if you’re not yet in. BUY.

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China Lodging Group (HTHT) has also popped back to its old highs during the past two weeks, though volume has been very light on the rally. Earnings are due on March 13, and the outlook for 2018 (analysts see earnings up 42%) will probably make or break the stock in the weeks ahead. HOLD A HALF.

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GDS Holdings (GDS) held its 50-day line during the market decline and has bounced decently (not great, not bad) since. There’s no set date yet for earnings, but the story remains powerful as data-center use booms in China and Asia in general. We’ll stay on Buy, though a drop below 23 or so would be a red flag. BUY.

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Melco Resorts and Entertainment (MLCO) doesn’t look terrible, but we’re going to pull the plug on it tonight because (a) its recent earnings report was just so-so, (b) the stock’s recent bounce has been so-so (very light volume and still plenty of overhead) and (c) many of our other stocks are acting better. Maybe the stock just needs more rest, but we’re going to pull up our stakes here and focus on stronger situations. SELL.

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Frankly, most energy stocks aren’t looking nearly as good as they did a few weeks ago, but Petrobras (PBR) is an exception—the stock has motored back to within just 3% of its prior high. Meanwhile, the company is making moves to put its past behind it—it’s aiming to sell a refinery it owns in Texas (which likely had some dirty money involved in it) and is taking bids on a pipeline it owns. Both are part of the firm’s goal of $21 billion of divestitures during the next couple of years to cut its huge debt load. Back to the stock, we’re game for grabbing a few shares around here. BUY A HALF.

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TAL Education (TAL) was placed back on Buy last week and it continues to act well. Bigger picture, TAL has been basing for 18 weeks and is back near the top of its structure, a positive sign. Of course, TAL’s had a huge run during the past year, and at some point, the stock will top out for longer than just three or four months. But buyers are still active, and with earnings growth expected to accelerate in the quarters ahead, we have high hopes. You can buy a half-sized position here or on dips. BUY A HALF.

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Tencent Holdings (TCEHY) has also bounced nicely during the past week and is within three points or so of its all-time high. We’ll stick with our Buy A Half rating. BUY A HALF.



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Vipshop (VIPS) looks great—we think it has big potential as a turnaround situation. The recent quarterly report topped estimates and analysts see earnings up 21% this year (likely conservative in our view). With all the weak hands out, the stock bounced beautifully off its 25-day line and has pushed to new recovery highs this week. Try to buy on dips. BUY.

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Weibo (WB) shot to new highs in the wake of its earnings report last week and has been pausing normally since. Analysts have again ratcheted up their estimates, with 55% and 42% growth expected this year and next. WB has had a huge, huge run since originally breaking out back in early 2016, so we are on the lookout for problems, but if anything, the buying pressures have intensified recently. You can start a position here if you’re not yet in, with a stop near 120. BUY.

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YY Inc. (YY) has bounced decently, but we’re content to stay on Hold and see how the upcoming earnings report (due March 5) is received. The major uptrend is intact and the selling during the correction wasn’t too intense. Sit tight if you own some, though there are stronger names to consider for new money. HOLD A HALF.


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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 March 8, 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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