In the first week of 2019, a better overall stock market, weaker U.S. dollar, bargain hunting, and hopeful signs of a temporary truce in the U.S.-China trade war have all helped push our Emerging Markets Timer back into a bullish mode.
As with our prior signals, we’re not advising you to jump in with both feet since there is still a fair amount of uncertainty out there and the iShares EM Fund (EEM) needs to demonstrate staying power and work through some resistance. Still, we are extending our line a bit with our two new buys in today’s issue.
Cabot Emerging Markets Investor 676
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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.
Our Emerging Markets Timer is back on the positive side of the fence, with buying pressure picking up in the New Year. You can see the iShares EM Fund (EEM) has popped back above its moving averages; there’s still resistance in the low 40s, but the intermediate-term trend is again turning up.
Bigger picture, the past couple of months look like a solid bottoming effort—EEM held its October lows in November and December, which is better than most markets, and now the buyers are beginning to flex their muscle. It’s not a sign to go all-in, but you should start extending your line and see if the nascent upmove continues.
Quick Overview
• The first week of 2019 has been kind to emerging markets with strength pretty much across the board. A weaker U.S. dollar, bargain hunting, China pumping some liquidity in the banking system, and hopeful signs of temporary truce in US-China trade war have all helped.
• Our Emerging Markets Timer turned positive yesterday with the iShares EM Fund (EEM) leaping above its key moving averages.
• We have two new recommendations in this issue: TAL Education Group (TAL), and Van Eck Rare Earths/Strategic Metals (REMX)
Turbulent Markets Create Great Opportunities
The biggest concern that I hear from investors about emerging markets is they pose too much risk. But the fact is, in the markets, many supposedly “safe” stocks (and markets) that attract conservative investors actually pose more risk than believed.
Today, I point to two of America’s bluest blue chips – Kraft Heinz (KHC) and FedEx (FDX).
These are truly great companies, no one is arguing that. But both stocks have nevertheless faced steep declines in their share prices as the companies have warned about slowing growth. Kraft Heinz has gone from $80 a share to the low $40s and FedEx has lost a shocking $100 per share in the last year to trade at around $165!
Fundamentally, for Kraft Heinz, the culprit is slower growth and a stronger U.S. dollar that has hit overseas earnings. For FedEx, it is fear of a challenge by Amazon and weaker growth in Asia and Europe. And these are just two among many “safe” stocks that have hit the skids not just during the sharp downturn in the fourth quarter but going back months before!
My point here is threefold. First, risk and volatility are part and parcel of investing in general—not just emerging markets, and not just growth stocks. Second, though, managing that risk by diversification—in part by having exposure to international markets – is important.
And third, using Cabot’s market timing, it’s a good idea to keep some cash on the sideline during down times to allow you to take advantage of turbulent markets that put opportunities on sale. For long-term investors, both FedEx and Kraft Heinz are probably solid ideas, though odds favor both stocks need bottoming processes before getting going.
That is exactly what I’m seeing in emerging markets, which as you know have been out of favor for months, with Chinese stocks in particular getting hit (the Shanghai composite index lost 25% in 2018).
This pullback has resulted in a bushel of Chinese stocks that have begun what I call “value bounces” in early 2019. There are many enticing names in this category, though of course I’m looking for the best of the best to recommend.
One example of a “value bounce” idea is iQIYI, Inc. (IQ), the subsidiary of Baidu that we owned for part of last year. IQ provides online entertainment services and operates a platform that provides a collection of Internet video content. Its share price went from around $40 a share in June 2018 to just $15 in late 2018. Since then, like many other Chinese stocks, it has begun an uptrend - rising to $19.
Another “value bounce” example is a new recommendation - TAL Education Group (TAL)—which fell from 47 in June to 21 in October, and after steadying itself for a few weeks, is back up to 29. (See my full write-up in this issue.)
Turning to the bigger picture, there remains a great degree of uncertainty about the Chinese economic growth and debt issues as well as the ongoing U.S.-China trade negotiations. My guess is that there will be some sort of positive development and a photo op with smiling faces. But trade, economic, political tension between the U.S. and China will be a backdrop for both markets for a long time, though that tension is unlikely to be as intense as it has been in recent months.
We’re not big on predictions, but given the big decline and now our new buy signal from the Emerging Markets Timer, now’s a good time to start putting money to work, slowly building positions in some high-potential names.
One of those ideas, as mentioned above, is Tal Education. But I have another for this issue as well—Van Eck Rare Earths/Strategic Metals (REMX), which (obviously) offers exposure to rare earths/strategic metals, an area that has come through the wringer. It was highlighted in my special report on the Electric Vehicle Revolution that was sent to you, and I write more about it below. Let’s dive in.
Featured Stocks
New Recommendation: Van Eck Rare Earths/Strategic Metals (REMX)
The Oil of the 21st Century
One of my favorite books is Daniel Yergin’s riveting tale of the major role oil played in the 20th century; The Prize: The Epic Quest for Oil, Money & Power. Oil not only powered the economy, it also played a pivotal role in the century’s statecraft.
The following sentence in the book’s prologue really caught my eye: “As we look toward the 21st century, it is clear that mastery will certainly come as much from a computer chip as from a barrel of oil.” But what’s behind the computer chip and advanced technology that forms the backbone for so much that we take for granted in modern life?
The answer is critical, strategic metals and, in particular, an important subset called rare earths. These vital ingredients are critical to economic growth and advancement of technology—sort of like the special ingredients of the age of technology.
Like yeast in making bread and wine, they are required in small quantities in all sorts of products from cell phones to advanced weapons systems, aircraft engines, robots and hybrid batteries. Rare earth elements (which, ironically, are not particularly rare), are very difficult, time consuming and expensive to extract and process.
The real value of these materials is their unique magnetic and electrochemical properties, helping to boost the efficiency, performance, speed and durability of many technologies—for instance, playing a big role in miniaturization and allowing for much lighter, stronger, resilient and efficient components.
One example is Neodymium. Many of the magnets around you have neodymium in them: speakers and headphones, microphones, computer storage, and magnets in your car. It’s also found in high-powered industrial and military lasers and especially important for green tech.
So how does this play into emerging market? Since the 1990’s, China has effectively become the Saudi Arabia of rare earths, as the country’s favorable geology, low cost labor and lax environmental standards allowed it to produce about 85% the world’s rare earth output.
After a long period of weak pricing and being off the front page (the group had a nice run a few years ago), rare earths are now back in the news with prices and headlines on an upward trajectory.
All of this is why I like the VanEck’s Rare Earth/Strategic Metals Fund (REMX), which launched in 2010. It’s fairly concentrated with 21 holdings - and the top 10 holdings represent 61% of assets and more than half of the holdings are Chinese companies involved in the rare earths field.
Overall, REMX offers diversified exposure to a basket of companies with a slant to China. It also offers a nice hedge on U.S.-China tensions since China has tremendous leverage to limit production or exports to the US if it chooses to play hardball.
After surging from 14 to 30 in the second half of 2017, this fund sunk right back down for most of last year, dropping all the way to 13 in December. The bounce since then isn’t the be-all, end-all, but I think this is a buy-low opportunity. Given that REMX isn’t in an uptrend yet, we’ll start with a half-sized position today. BUY A HALF.
New Recommendation: TAL Education Group (TAL)
Profit from China’s Hyper-Competitive Education System
All students in China have to prepare for the Gaokao, the National Higher Education Entrance Examination, which is the basis for recruiting students for institutions of higher education. This nine-hour exam is a killer with only 40% of students passing, which means Asian parents are more than willing to spend some money for that extra edge.
That reality plays into the hands of TAL Education, one of the leaders in the for-profit education business in China. The company offers comprehensive tutoring services to students from preschool to the twelfth grade through three flexible class formats: small classes, personalized premium services and online courses, while its tutoring services cover the core academic subjects in China’s school curriculum such as mathematics, English, Chinese, physics, chemistry and biology.
In total, TAL boasts an infrastructure of 650 learning centers in 45 cities as well as offering a robust online platform. It is just short of serving five million students.
In addition to improving its own offerings, TAL has focused on acquisitions and strategic investments. A couple of years ago, the firm swallowed up Firstleap Education, a Chinese company that provides online and offline tutoring for children, and investing $30 million in Phoenix E-Learning, which operates China’s largest online education platform. Both have been integrated into TAL’s platform.
Finally, it doesn’t hurt that TAL’s business is unaffected by U.S.-China trade negotiations or currency fluctuations; yes, if China’s economy really implodes, maybe education gets crimped, but the odds are strongly against that.
The company has been investing heavily in its business, and it’s paying off in spades—in the quarter ending August 31, TAL’s revenues rose 54% while student enrollment surged 120%. That heavy investment has crimped earnings growth a bit (the bottom line was up “only” 33% in the most recent quarter), but analysts see earnings ramping 50% in the fiscal year that begins in March.
Despite these strong numbers and bright future, TAL stock took a beating in the second half of 2018. But it began showing relative strength in October—the stock bottomed around 21 then, rallied on big volume after earnings that month, and held near 25 during the December market meltdown. Now it’s beginning to push higher again. I think it’s a nice bottoming formation and will start with a half position here. BUY A HALF.
TAL Education Group (TAL)
Danling SOHO
15th Floor 6 Danling Street Haidian District
Beijing 100080, China
http://www.100tal.com
Model Portfolio
Invested 40% Cash 60%
Updates
Stocks have turned very strong since the Christmas low, and that’s been enough to flip our Emerging Markets Timer back into a bullish mode. As with our prior signals, we’re not advising you to jump in with both feet—in fact, the iShares EM Fund (EEM) still has some overhead to chew through, similar to most stocks and sectors. But we are extending our line a bit with our two new buys in today’s issue
We did trim some positions in last week’s update, but if this rally continues to gather steam, we’ll be putting more money to work in the days ahead.
Alibaba (BABA) made a nice move from $136 to $150 in the last week. The company also announced its purchase of German data analysis firm Data Artisans in a deal reported to be worth $103 million. HOLD A HALF.
AngloGold Ashanti (AU) has done its job since being added as a nice “shock absorber” in an uncertain market. We like the new uptrend and think gold stocks, after being in the doghouse for a few years, could be ready for a run. We’re OK buying a half position here or (preferably) on dips of a few dimes. BUY A HALF.
MiX Telematics (MIXT), was pretty much flat this week on low volume, underperforming the iShares EM Fund on a relative basis. Still, the valuation is reasonable and shares are still well above their October low. This recommendation got off to a poor start before finding its footing. We will stick with our half position and will see how it acts in the coming week. HOLD A HALF.
Nio (NIO) is a $7.9 billion Shanghai-based company listed on the NYSE that we added to the watch list last month. It’s a great play on China’s commitment to rapidly developing what is already the world’s largest electric vehicle (EV) market. The stock showed some weakness last week but remains in its general 6 to 8 trading range. WATCH.
Tencent (TCEHY) has gained some ground this week. The Chinese government ended their moratorium on the release of new games but limited the first round to smaller players. Fortunately, TenCent has a stake in Epic/Fortnite. BUY A HALF.
Vale (VALE) has made a nice move in the last week along with the market and more favorable view of Brazil in wake of recent election. A general rebound in materials stocks (thanks to an improved worldwide economic outlook) has also helped. I will likely feature other Brazil recommendations in the months ahead; as for VALE, we’ll stick with our position. HOLD.
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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 January 24, 2019
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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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