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Cabot Emerging Markets Investor 665

While emerging market stocks (especially Chinese stocks) remain under pressure, we’re starting to see some signs that things may be turning around. Our stocks have been knocked around a bit by earnings season, but we’ve also had some good winners. And we continue to build a watch list of companies with excellent stories and intriguing charts that we will be ready to buy when the general tone of the market improves. Read on for my view on what’s happening right now and why it’s a good time for optimism.

Cabot Emerging Markets Investor 665

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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.


Our Emerging Markets Timer is technically still on the Buy signal from two weeks ago, though the next few trading days will be crucial. You can see that the iShares EM Fund (EEM) has pulled back a bit since rallying to 45, but so far it’s held support at its lower (25-day), rising moving average, which is enough to keep the nascent buy signal intact.

That said, for all intents and purposes, the trend is effectively sideways at this point, with some areas holding firm and others (like most Chinese stocks) still in steep downtrends. We’re taking things on a stock-by-stock basis, dumping names that crack but keeping our eyes open for indications of new leadership should the EM Timer push higher from here.

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Rain

There’s a little paranoia in the souls of many growth stock investors. Let’s face it, sometimes it feels like the stock market is a rainstorm that has you directly in its sights while leaving your neighbors safe and dry.

If you’re an emerging market investor, that’s not just how if feels, it’s how it is.

The escalating trade war between the U.S. and China is making a genuinely toxic environment for Chinese ADRs, some of which are directly affected and some of which are just suffering from investors’ twitchiness.

We got a good illustration of the dampening effect of country-specific negative sentiment on Wednesday, when both Autohome and ZTO Express reported their Q2 results before the market opened.

While both reports were ahead of analysts’ expectations, the reaction to each report was very different. Investors liked the news from ZTO Express, but their approval only gave ZTO a boost of 1%, while the negative reaction to Autohome’s news dropped the stock by almost 9%. Clearly, China is a tough sell right now. (And if you’d like a more objective illustration, a quick look at the MSCI Emerging Markets ETF (EEM), which is still holding onto its green light despite a continuing correction that began in January, and the Golden Dragon ETF (PGJ) which is lower than a snake’s belly in a wagon rut with no signs of support showing up.

The conclusion I draw from this is that fear of the trade war is sapping enthusiasm for good news and upping the penalties for disappointing news.

My response to these rocky market conditions, following Cabot’s time-tested rules for growth investing, has been to lower the portfolio’s exposure to emerging market risk in general (and China specifically) by putting more and more of our capital into cash. This is the equivalent of staying indoors when it rains, which is a much surer way of staying dry than the best umbrella.

Trying times like these may make some investors question the wisdom of investing in emerging market stocks at all. Why take on all that risk, they ask, when a diversified portfolio of stocks and bonds will give you hands-off protection and performance in the long run.

My answer is that, while that approach may work in the long run, in the short run (remembering the years 2000 and 2008) it can also cut your portfolio off at the knees.

And as an optimistic realist, I know that exposure to well-selected emerging market stocks, when the market is working in your favor, is just too good an opportunity to miss.

Cabot Emerging Markets Investor will make bigger gains than the general run of emerging market stocks when market trends are positive and will lose less than the emerging markets indexes when conditions are negative. And when conditions are right, the profits can come in bunches, as we saw last year.

In going through the entire list of emerging market ADRs in preparation for this week’s issue, I noticed that many of the South American stocks staged nice bounces during July, which is one factor keeping EEM as close to a buy signal as it is. Those stocks still have a ton of overhead to work through, but it’s a start.

Accordingly, it seems like a better idea to look for a fresh new idea, rather than taking a beaten down stock and betting on a continuing recovery. And today’s stock is about as fresh as you can get.

With lots of cash and some wary optimism, we’ll get through this rough patch just fine.

Featured Stock

Watch and Wait
Huya Inc. (HUYA)

For traditional television sports fans in the U.S., the sports year is divided between the traditional leagues (NFL, NBA, MLB, NHL, etc.) and special occasion viewing like Wimbledon, the Masters, the Kentucky Derby and the like.

But there’s a new sports viewing phenomenon that’s hugely popular online and is making inroads on cable as well, and that’s esports. (If it were up to me, I’d spell it “e-sports,” but that would be too old-fashioned.)
Esports translates to watching professionals playing video games, and while it may sound like something that wouldn’t catch on, it’s fast becoming a big deal—including an estimated global audience of 167 million this year and forecasts of 427 million by 2019! (That’s larger than the size of the current NFL audience.) For a little perspective, you can go to overwatchleague.com, which is an eye-opener. There’s even talk about esports being in the Olympics in 2024.

Huya Inc., a Chinese esports company, is the top live streaming platform for esports in China, with the largest number of monthly average users (86.7 million), the most time spent on its mobile app per user and the most active broadcasters. The company streams game play and tournaments for mobile devices, PCs and cable, and sees big potential for leveraging its platform’s user base to expand into other entertainment fields. Industry-wide, game streaming generated $1.2 billion in revenue in 2017, and that’s projected to more than quadruple to $4.9 billion in 2022.

Huya Inc. just launched operations in 2016, so there’s not a long financial history, but it booked its first profit in Q4 2017. The company’s Q1 report in May showed 132% revenue growth, which was the fifth consecutive quarter of triple-digit sales gains. Earnings, which were one cent per share in Q4 2017, increased to five cents per share in Q1.

Huya Inc. is aided in its expansion by its relationship with its parent company, YY.com. Huya also got a $462 million cash infusion from Tencent Holdings in March, a deal which also secured Tencent the right to purchase additional shares to reach 50.1% of Huya’s voting power.

HUYA came public on May 10 at 12, but caught a dramatic updraft that took it above 50 by the middle of June. After that overheated peak, the stock needed some down time, and it pulled back to 28 on July 6. Interestingly, though, shares then bounced to 40 on massive volume—the weekly volume was far larger than anything the stock had experienced before. And since then, while HUYA has dipped, it’s remained above its June low (far more resilient than most Chinese stocks) and volume has dried up in a big way.

Stocks this young (it just picked up a 50-day moving average on July 23) are often big movers, and with the trade-war turmoil affecting Chinese stocks in general combined with the company’s upcoming earnings report on August 13 after the market closes, there are plenty of sources for volatility, including a possible U.S. IPO from major esports rival Douyu, although there’s no announced date for that yet.

Analysts are looking for earnings of 29 cents per share this year and see that figure doubling to 60 cents in 2019, but we think that could prove conservative if the company makes the right moves.

The emotional environment for Chinese stocks is not great right now, but I think there’s a good amount of skepticism already priced into HUYA. The stock took a small hit when a Goldman analyst started coverage on the stock with a neutral rating, saying it was fully valued. At the same time, HUYA has been acting stronger than the general run of Chinese ADRs, holding above support while the Golden Dragon ETF (PGJ) has been skidding to new correction lows.

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I don’t advise taking a position in HUYA two days before earnings. The pressure on Chinese issues is just too strong right now. But this is an ideal candidate for our watch list, one with a strong position in a large, growing industry with enormous potential. I’ll be watching the company’s report and, more importantly, the reaction from investors. If the reaction is positive, the story is strong enough to power good performance despite market conditions. WATCH.
HUYA Inc. (HUYA)
Building B-1
North Block of Wanda Plaza No. 79 Wanbo 2nd Road Panyu District
Guangzhou 511442
China
http://www.huya.com

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Model Portfolio

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Invested 45% Cash 55%

Updates

Emerging Market stocks as a whole have stabilized in recent weeks, and the intermediate-term trend is beginning to turn up. That said, it’s a very mixed and rotational environment—Chinese stocks remain under heavy pressure, while some beaten-down names from other emerging market countries have perked up.

Because of our exposure to Chinese names, we pared back a bunch during the past few weeks and have been holding a large cash position of 55%.

That said, we’re not all-out negative or predicting bad things; if anything, we think the horrible news environment (especially for Chinese stocks) is “reloading the cannon” for the next advance, when sentiment improves. For now, though, we’re mostly focused on preserving capital until a firm uptrend gets underway, and, of course, keeping our eyes open for potential new leadership from stocks that are resisting the market’s wobbles.

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Some stocks scare you out with sharp, multi-week downtrends, while others go generally dead for many months and wear investors out. We think Alibaba (BABA) is doing the latter, having carved out a reasonable 21%-deep range since last September (!), with plenty of ups and downs during that time. We’re encouraged that, despite the awful performance in many Chinese names, the stock remains well above its correction lows in the mid 160s. Yes, it’s tedious, but we’re planning on holding the stock as long as it can remain above those lows. Earnings are due out August 23, which will probably determine whether this whole pattern is a meaningful top or not—given the relative resilience from the stock and the pristine fundamentals, we remain optimistic the next big move is up. HOLD.

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Autohome (ATHM) released what looked like a solid second quarter report, with revenues (up 22%) and earnings (up 32%) both topping expectations, and the firm expects similar growth in Q3. The stock, though, is telling a different story, first with four straight days of big-volume selling last week, and then yesterday’s plunge to its 200-day line following earnings. We will hold on as long as we can, but a close below the 200-day moving average will likely trigger a sell. HOLD.

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BeiGene (BGNE) has been busy on the news front of late. First, it completed an initial public offering in Hong Kong, raising about $900 million in the process. It then reported quarterly results, which was really more of a summary of its progress on trials and regulatory moves year-to-date. And it also announced the start of a new Phase III trial for one of its key cancer treatments in concert with chemotherapy. After rallying nicely from its lows in late June, the stock has pulled back reasonably and found some support today. We advise holding onto your half position. HOLD A HALF.

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GDS Holdings (GDS) has bounced back a bit from its abnormal selloff two weeks ago, but there’s still a ton of damage to repair. Eventually, if the short seller accusations are proven wrong, GDS could rebuild a new launching pad, but given the state of Chinese stocks (weak), investors are in a guilty-until-proven-innocent state of mind. We sold and are holding the cash. SOLD.

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iQIYI (IQ) continues to slip with Chinese stocks, but we’re still OK with it given our half position, our profit and the low volume dip here while Chinese stocks cave in. We’re not going to let IQ melt away, but given its great growth profile (revenue growth is slowing a bit but is expected to remain in the 40% to 50% range going forward) and prior run, we’re hanging on. And if you don’t own any, you can buy a half position around here. BUY A HALF.

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JD.com (JD) continues to hold support in the 34 to 35 area, which is a great sign of resilience given what most Chinese stocks are doing. Fundamentally, the firm continues to expand its reach with the help of some big partners—JD and Walmart just announced a joint $500 million investment in an online local delivery service (from grocery stores and other partners) that was created in part from one of JD’s subsidiaries; the outfit has about 20 million monthly users. Back to the stock, the longer JD can hold up in this area, the greater the chance it’s etching a major bottom. Earnings are due out on August 16. We’re OK buying a little here if you’re not yet in. BUY A HALF.

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RYB Education (RYB), which was our recommendation in the last issue, is acting well, holding above its 50-day line and actually perking up a bit this week. Of course, the stock is very thinly traded, so some big swings are possible, but the stock came out of a seven-month bottoming effort in June, and has etched some higher lows since then. Combined with its excellent growth prospects (analysts see earnings up 65% this year and 150% next), we think this “early stage” opportunity can do very well once Chinese stocks stabilize. Earnings are due out August 27. You can pick up a few shares around here. BUY A HALF.

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WNS Holdings (WNS) is generally a steady performer, and sure enough it’s bounced back nicely from its late-July plunge. It’s not strong enough for a buy rating, but if it consolidates a bit longer and then resumes its advance down the road, it should provide a solid entry. Keep it on your Watch List. WATCH.

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ZTO Express (ZTO) is another stock we have high hopes for given its rapid growth, huge market and relatively resilient chart. The firm’s second quarter results (reported last night) were terrific, with local currency revenues rising 41%, EBITDA up 38% and earnings per share up 107% from a year ago. The sub-metrics were a thing of beauty as well, with a 42% jump in parcel volume and continued expansion in the number of pickup/delivery outlets (now 29,500!), 83 sorting hubs and 4,700 vehicles in operation. And this all comes with management’s admitted emphasis on parcel and market share growth—for Q3, the top brass expects 35% to 38% parcel growth, with net income up around 40%. ZTO rallied on the news, and big picture, remains in a reasonable range (~19 to 22), which is encouraging given the prior run-up and the action of Chinese names. BUY 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 August 23, 2018

We appreciate your feedback on this issue. Follow the link below to complete our subscriber satisfaction survey: Go to: www.surveymonkey.com/chinasurvey
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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