Cabot Global Stocks Explorer 715

U.S. markets are trading cautiously with the latest uncertainty surrounding the coronavirus pandemic. Chinese markets have surged over the last week and I’ll outline a trading idea to take advantage of the momentum. Our emerging market (EEM) signal is decisively positive as our portfolio moves ahead, led by our Alibaba (BABA) position, up 18% this week, and Sea Limited (SE) continuing its incredible run. Today, we discuss changes afoot in Hong Kong with a new recommendation that is an undervalued throwback blue chip that is also a high-quality proxy for Asian growth.

Cabot Global Stocks Explorer 715

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Hong Kong Becomes More Chinese, Less Global
It was another good week for the Cabot Global Stocks Explorer portfolio with Alibaba (BABA) up 18%, our strategic metals/rare earths ETF and Kirkland Lake Gold (KL) both increasing 13%, and Sea Limited (SE) surging 10% yesterday to an all-time high.

The speculative Chinese electric vehicle company Nio (NIO), which I highlighted in a special report, is also on a roll and has more than doubled in the last month, pulled along by the tremendous interest in Tesla and its competitors.

Beijing is encouraging a bull market with its state-owned China Securities Journal, calling in an editorial for a “healthy bull market.” The editorial’s tone reminds me of a rally in 2014-2015, which saw the market more than double in about six months.

China is definitely a momentum market that can be both volatile and unpredictable. We don’t know how long this current rally will last but for aggressive traders, I suggest adding a small allocation to Direxion Daily FTSE China Bull 3X Shares (YINN) leveraged ETF that moves three times the market in either direction. Please put in place a 20% trailing stop loss for some protection in case the market goes the other way.

Meanwhile, Hong Kong is becoming an active center for trading in some of China’s largest technology groups, as companies seek secondary listings of U.S.-listed Chinese companies. For example, Hong Kong now represents almost 20% of the shares changing hands by value in Alibaba (BABA) following its Hong Kong listing in November 2019.

Today’s new recommendation is a blue-chip Hong Kong conglomerate with roots going back to the early 19^th century. It is a value play in a Hong Kong that is moving from being the Asian and perhaps even the global capital of financial markets to just another important Chinese city. The ramifications of the new Chinese national security law and administration will take time to play out but no doubt will be significant.

New Explorer Recommendation
Hong Kong Blue-Chip Conglomerate on Sale
Swire Pacific (SWRAY)
Hong Kong is a story of progress and a symbol of how a combination of religious and social tolerance, together with economic freedom, built one of the most prosperous, cosmopolitan and dynamic places in world history.

I first started visiting Hong Kong in the 1980s as a corporate banker and then later pitching U.S. stock research and ideas to Hong Kong institutional investors. Later, I followed the negotiations leading to the turnover to China in 1997 quite closely, and with a well-warranted skepticism.

Over the years, Hong Kong has established a well-earned tradition of being one of the most open, entrepreneurial and international economies in the world. This is why 1,389 multinationals based their regional headquarters there in spite of the fact that rents were triple that of Shanghai. One reason is that it is home to 7.5 million industrious and talented Hong Kongers and has a very competitive tax system and light regulatory burden.

According to the closely followed 2020 Heritage/Wall Street Journal Index of Economic Freedom, Hong Kong ranked #2 just behind Singapore while America ranked #17 and China came in at #103.

The protests in Hong Kong over the last year have raised some important issues and, unfortunately, China has responded by imposing a new national security law and this will no doubt impact its future. The new Committee for Safeguarding National Security has broad new police powers, including the ability to conduct warrantless searches.

The bottom line is that Hong Kong has little leverage to fight back against these measures. While in the 1980s, Hong Kong represented about 30% of China’s GDP, it now accounts for only 3%.

As you might expect, some Hong Kong shares have pulled back over the last six months, presenting us with a great entry opportunity. There are two blue-chip conglomerates with a long history in Hong Kong that I have followed closely and have greatly admired over the years: Jardine Matheson (JMHLY) and Swire Pacific (SWRAY).

Founded in 1832, the Jardine Matheson is incorporated in Bermuda but headquartered in Hong Kong. A substantial amount of its profits are from greater China, with even more coming from Southeast Asia.

Here is just a sampling of its diversified businesses. It owns the region’s leading supermarket and health & beauty chain; the 7-Eleven convenience store chain; IKEA furniture stores; and operates the Starbucks franchise in Hong Kong. Jardine owns large amounts of prime commercial property in the heart of Central Hong Kong, where its buildings form an interlinked network of offices and retail space. The company also currently owns or has substantial interests in 15 hotels worldwide including the Mandarin Oriental as well as car dealerships in Hong Kong, Macau, China and the U.K.

The other esteemed Hong Kong blue chip is Swire Pacific (SWRAY). Founded in 1816 and headquartered in Hong Kong, Swire is active in a wide range of commercial activities throughout Asia including aviation, property and retailing. According to its website, Swire owns 23 million square feet of property, the premier airline Cathay Pacific, 18 Coca-Cola plants and distribution rights in Hong Kong and parts of China and Southeast Asia, plus extensive retail businesses in fashion, food and auto.

Both of these blue chips are way off their 52-week highs and substantially below their book (break-up) value.

It was a tough call, but I’m inclined to go with Swire Pacific because it has a much less complex corporate structure and is trading at only about 25% of its book value and therefore probably offers more upside potential. I’m sure there are some concerns about its flagship Cathay Pacific airline, but all indications are that its Asian operations will recover to profitability much more quickly than major U.S. and European carriers.

I recommend that we buy into old Hong Kong for some new growth and profits through Swire Pacific. BUY A FULL POSITION

Model Portfolio

Portfolio Changes
Cloudflare, Inc. (NET) from Buy a Half to Buy
Direxion Daily FTSE China Bull 3X Shares (YINN) New Buy Small Position (for traders)
Swire Pacific (SWRAY) New Buy

Updates
Alibaba (BABA) shares were up 18% this past week as Chinese stocks surged and the company announced plans for a Hong Kong IPO for its minority-owned Ant Group.

Ant Group, which is 33% owned by Alibaba, plans a Hong Kong offering worth more than $200 billion. In addition, BABA recently announced plans to invest an additional $28 billion in cloud technology over the next three years, including operating systems, servers, chips and network. The investment is equivalent to about half of Alibaba’s revenue in fiscal 2019. This is a big number considering that its cloud business represented just 6.6% of the company’s overall revenue in fiscal 2019. This segment has been growing at an average of 100% annually over the past five years.

On the negative side, India announced a boycott on Chinese goods and services due to a border conflict with China. Alibaba’s stakes in certain Indian services are rather substantial. For instance, it holds a 40% stake in popular payment app Paytm and has a substantial stake in Zomato, India’s leading food delivery platform.

Cloudflare (NET) shares were up just short of 8% this week and more than 30% over the last month. I expect its next earnings report, on August 6, to reflect the growth of cybersecurity services as online activity has ramped up during the pandemic. CEO Matthew Prince stated in an interview this week that over the last three months, global internet traffic is up more than 50% and NET blocks 400,000 attacks against political campaigns on a typical day. This is an aggressive web infrastructure and website-security firm gaining attraction in this competitive high-growth sector. There is a lot of momentum here for the stock and in this space, and I recently upgraded NET from buy a half to buy a full position. BUY A FULL POSITION

Global X Cybersecurity ETF (BUG) shares edged up 5% this week.

The formula driving this ETF forward is that higher activity online requires more cybersecurity measures. The companies in the BUG basket address online security as cybercrime, which has reached an all-time high. The top 10 companies in the BUG basket represent 56% of BUG’s market value. The stocks are not cheap and on average trade at more than six times book value. I’m fine with new subscribers buying BUG, which represents a conservative way to invest in a competitive industry. HOLD A HALF

DBS Bank (DBSDY) shares edged above 63 and offer investors a 12%-plus forward dividend yield. My target price is 70, which is reasonable given the bank’s quality and book value of 55. DBS is perfectly positioned to exploit growth in Southeast Asia with its 640 million youthful and tech-savvy consumers. The bank also has a growing presence in mainland China and India. I encourage you to aggressively buy DBS shares at this price. BUY A HALF

Gilead Sciences (GILD) shares were flat this week after the drug maker said it started a Phase 1a clinical study testing an inhaled version of its experimental COVID-19 drug remdesivir. The Food and Drug Administration in May granted an emergency use authorization to an intravenous form of remdesivir as a treatment for some severely ill COVID-19 patients.

Currently, remdesivir has emergency use authorization in the U.S. to treat patients with severe and moderate COVID-19 in hospital settings. It’s given as a five- or 10-day infusion. From the beginning, it’s been clear that Gilead planned to develop a coronavirus treatment solution for outpatient uses. If you haven’t yet purchased GILD shares, I encourage you to buy a half position. BUY A HALF

Kirkland Lake Gold (KL) shares were up 15% this week and 22% since being added to the Explorer portfolio two weeks ago as the gold bull market rolls on. Kirkland fits the formula for the ideal conservative gold stock: rising production of gold, superior profit margins and a strong balance sheet. The company ended the most recent quarter with $531 million in cash equivalents and has no debt and exceptionally low production costs. Kirkland’s latest quarter delivered 40% profit margins, 14.7% return on assets and 22.9% return on equity. If you have not yet invested in Kirkland, I encourage you to buy a half position. BUY A HALF

Sea Limited (SE) shares were up 10% yesterday to reach 125 as Citi raised its target price to 138 and Bank of America increased its target to 135. Sea is at the sweet spot of Southeast Asia’s e-commerce, gaming and digital banking all moving briskly downstream due to the impact of COVID-19.

This growth in top-line revenue and stock price has been more than impressive, but just a note of caution: Sea has incurred net losses over the last 12 months of $1 billion along with a negative free cash flow of $340 million. Profits will likely follow as it builds out its market share, which is growing day by day aided by its partnership with Tencent. I encourage owners of Sea to take some profits if they have not already done so and only the most aggressive investors to buy at these levels. HOLD A HALF

Trip.com (TCOM) shares were up only marginally this week despite a good week for Chinese stocks, indicating a lack of relative strength. I moved this stock to a hold last week. We’ll give it another week to see if it catches up. I realized that the Trip.com story might take some time to develop, and the company has recently announced a number of marketing initiatives, a flex booking guarantee, and launched international initiatives with over 30,000 hotels in 180 countries. HOLD A HALF

VanEck Vectors Rare Earth/Strategic Metals ETF (REMX) shares jumped 13% this week as this China-heavy basket of strategic metal and rare earths companies surged. These materials are vital to a wide range of advanced technology and defense applications and China has a quasi-monopoly position on many of them so REMX serves as an effective hedge on the risks around rising U.S.-China tensions. I encourage you to buy a half position if you have not already done so. BUY A HALF

Virgin Galactic (SPCE) shares traded this week in a narrow range, ending largely unchanged. While SPCE has announced a number of favorable partnerships and interest in the story remains high, it seems that some targets and milestones may be slipping a bit. Last year, founder Richard Branson said that flights will begin within a year, and he expected profitability by 2021.

But his intention to fly aboard the first commercial SpaceShipTwo flight for his 70th birthday this month seems improbable. This slippage may not impact the stock since Wall Street seems focused on Virgin Galactic’s potential in hypersonic intercontinental travel. The company said in May that it’s entered into a Space Act Agreement with NASA on developing a sustainable high-mach supersonic vehicle. The U.S. space agency has been working on high-mach flights with its Supersonic X-59 test plane, built by Lockheed.

I rate SPCE a strong buy for aggressive investors. This is a compelling story with a quality management team in a potentially high-growth market. Vertical Research Partners’ Darryl Genovesi reiterated his buy rating on SPCE with a target price of 29, substantially above the current price of 17. BUY A FULL

The next Cabot Global Stocks Explorer issue will be published on July 23, 2020.

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