How does Cabot’s China newsletter do it?

By Peter Brimelow, MarketWatch, June 15, 2008

NEW YORK (MarketWatch)—Chinese stocks are still staggering downward, but a China service is by far the best performing investment letter. How?

The Shanghai Composite is down 50% from its 2007 peak. And, after a rally in April, it has just lurched downward again.

Yet Cabot’s China & Emerging Markets Report (CCEMR), which we named Investment Letter of the Year for 2007, continues its remarkable run.

CCEMR is the top performer over the past 12 months according to the Hulbert Financial Digest, up a remarkable 108.7% vs. negative 6.31% for the dividend-reinvested Dow Jones Wilshire 5000. And this success is sustained: Over the past five years, the letter has achieved a 32.76% annualized gain, vs. 10.92% annualized for the total-return DJ-Wilshire 5000.

Year to date through May, CCEMR has slowed, slightly. It’s the Number 2 performer, up 26.6%. But the year to date top performer is only just ahead: Forbes Special Situation Survey, up 28.1%.

Partly, the answer seems to be that editor Paul Goodwin sticks to a disciplined moving-average system, which he calls his China-Timer. It’s now decisively negative and he’s 40% in cash. This is a change. He used just to retreat to his strongest stocks.

Another part of the answer: Goodwin is extremely agile. For example, he expanded to cover other emerging markets in 2006, although for a long time his stock-selection methods kept him in China, which worried him.

Commenting on China’s recent volatility, Goodwin writes philosophically: “But let’s get serious here for a minute. If we weren’t prepared to tolerate this kind of treatment from the emerging markets, we’d have our money safely stuffed into blue-chip funds or government bonds.”

His diagnosis: “Global markets, both emerging and developed, are nervous because there is still an enormous bowl of bad mortgage-backed debt on the table and eventually someone is going to have to eat it. You can’t feed it all to the dog. And if too much of that bad debt winds up on the plate of a big financial house like Lehman Brothers (which has already announced a $2.8 billion loss for the second quarter), the results could be very bad indeed. The collapse of a financial major would be a real rat in the global punch bowl.”

His cautious conclusion: “As usual, we have no predictions. The U.S. economy, no longer the high-revving engine of the global economy, may escape the threat of recession, which will raise housing prices enough to allow the holders of bad debt to get rid of it at tolerable levels. The positive results would be felt around the world. We can all hope; meanwhile we keep watching our charts.”

CCEMR has radically reduced its portfolio. Currently, only these stocks are rated as buys:
• Petroleo Brasileiro SA Petro. (PBR), the Brazilian oil producer
• Companhia Siderurgica Nacion (SID), the Brazilian steel producer
• Sadia SA. (SDA), the Brazilian meatpacker
• Sohu Com Inc. (SOHU), the Chinese internet portal