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Three Vital Tips for the Chinese Stock Market

As U.S. stock markets continue to drag, the Chinese stock market is an ideal alternative for growth investors. Here’s how to find the best Chinese stocks.

The S&P 500, the Dow and the Nasdaq are all dragging along, weighed down by worries about the Fed, the grinding unpleasantness of U.S. presidential elections, the slow-motion disaster of Brexit and the acute pain of Deutsche Bank’s face plant.

Where’s a growth investor to turn?

If you’re prepared to take the advice of a veteran of dozens of rides on the emerging markets roller coaster, I have three words: Chinese Stock Market.

There’s nothing really wrong with U.S. markets. Their long-term trend is still up and their medium-term trend is more sideways than down. And there are plenty of U.S. stocks that are performing well. Really well.

But one of the major rules in the Cabot growth disciplines is that you should move heavily into a market only when momentum is on your side. A bullish market improves the odds that you will make money when you buy a new stock and increases the size of your profits. So when the chart of the S&P 500 looks like this, it’s best to pull in your horns a bit.

And if you compare that chart with the chart of PGJ, you’ll see that the wind for Chinese stocks (at least those that trade on U.S. exchanges as American Depositary Receipts) is far more favorable for growth investors.

So here are three tips that will help you find some gems in the Chinese stock market.

Tip One: Look for the strong chart. For anyone who follows Cabot’s growth advisories, this won’t be a surprise. Good growth stocks have strong charts, period. That doesn’t mean that a chart has to be blasting off like a moon shot, of course. Strength can look like a stock with a nice flat base and the beginnings of a rally on increased volume. Or it might be a stock that has rallied well and is taking a break with a calm pullback or a period of sideways trading.

What you don’t want is a stock that shows no signs of either price strength or volume support. If the broad investment community isn’t interested, you shouldn’t be either. (And if average trading volume doesn’t come up to 400 thousand shares a day, there may not be enough buyers to fuel a big run.)

Tip Two: Look for the big story. While niche players can be interesting, a great growth stock needs a huge addressable market. That’s why Chinese online companies have such great potential; selling goods, services and games is a heck of a lot easier when your target includes every mobile and smartphone user, a number that comes to around 700 million these days.

As an example, here’s a chart of Line Corp. (LN), a Japanese company that’s a subsidiary of a South Korean company that addresses the whole of Asia with its IM and chat services that feature instant translation among Chinese, Japanese and Korean. LN hasn’t been public for long, but its big story is attracting enough investors to produce a strong chart. Here’s what the chart looks like.

Tip Three: Keep some cash around. While the Chinese stocks that trade on U.S. exchanges are doing well, the state of mind of U.S. investors is still pretty conflicted. Worries about all those things in my first paragraph are keeping the sun from shining for many investors. The best way to handle your growth portfolio is to let your winning stocks run, but pay strict attention to keeping your losses in check. Don’t let your losers get away from you!

And some of the money in your investment account—whether it hasn’t been invested yet or represents the proceeds from a sale—should be kept in cash. At this point, Cabot Growth Investor and Cabot Global Stocks Explorer each have between 20% and 30% of their portfolios in cash. That cash lowers your exposure, insulating you from damage by a dip in the market. It’s also your resource if the markets strengthen into a new bull move. A cash position is a cushion and a comfort when markets are in a nasty mood, and a resource when the uptrend resumes.

When everything is working right—Issues in the Chinese stock market are up, U.S. stocks up and investors in a bullish mood—then you can move toward full investment.

Every week, I look at the charts of every single emerging market ADR that trades on a U.S. exchange. And I see similar patterns over time. Lots of EM stocks started new uptrends in January and February. And more than a few stocks have done the “I’ve fallen and I can’t get up” thing.

Over the years I’ve been recommending emerging market stocks, I’ve learned that a couple of dozen companies in my investment universe have what it takes to be consistent contenders in the growth stock derby. They have the products, the capital, the management and the markets to have a shot at leadership.

I call these stocks “old friends,” and when their charts tell me that investors are pouring money into them, I’m always willing to take another ride.

If you’d like to have my experience on your side as you look for great growth stocks, I’d be happy to be your guide to the Chinese stock market and every other emerging market around the globe. My results have been great during this last bull run, and I have plenty of strong picks left to bring you.

Fortune Cookie

“If a man will begin with certainties, he shall end in doubts; but if he will be content to begin with doubts, he shall end in certainties.”

? Francis Bacon, The Advancement Of Learning

Mike’s comment: In real life, it’s usually best to have some conviction and stick-to-itiveness. But in the market, there is no certainty, so why would you be certain about anything? Yet that’s just how many novice investors operate, working from a position of surety and, oftentimes, ending up dazed and confused. It’s better to be a bit childlike when it comes to the market—having an open mind to any possibility, ignoring your ego and listening to the message of your stocks and the major indexes.

Paul’s comment: Francis Bacon, an English philosopher and statesman born in 1561, has a good claim to be the last man in the world to know everything there was to know. But the scientific method he advocated contributed to the flood of knowledge that made that claim impossible. I’ve always loved Bacon’s ability to allow experience to change his mind, always looking for experience of how things actually work. His observation on skepticism is useful to any investor, new or old.

Paul Goodwin is a news writer for Cabot’s free e-newsletter, Wall Street’s Best Daily.