While U.S. indexes have been choppy-to-down during the past few weeks, emerging market stocks remain in good shape and our Emerging Markets Timer is positive. Our new recommendation tonight looks like one of the best ways to play the general boom in electric vehicle production in the years ahead.
Cabot Emerging Markets Investor 640
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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.
Despite some hiccups, our Emerging Markets Timer remains bullish, telling us the intermediate-term trend is still pointed up. U.S. and many world markets have had a rough go of it in recent weeks, but emerging market (and especially Chinese) stocks are resilient, as the iShares EM Fund (EEM) held its 50-day line last week and hit a new closing high on Tuesday. That tells us to keep our optimist’s hat on.
The action among individual stocks has been a bit hit or miss, as you’d expect, but many of our recommendations continue to perform well. We’re cutting any stocks that break down, we’re still holding our winners and looking for new buying opportunities as they emerge.
The Reality Principle
Like all growth investors, I have a few favorite wise sayings that I count on to keep my feet on the straight and narrow when markets get dicey. And the one that I’m thinking of right now is: “The chart is the only reality; everything else is just commentary.”
That doesn’t mean that I don’t read the commentary, but it explains why the Cabot Emerging Markets Timer looks only at a chart that shows what’s happening to EM stocks on a daily basis. If the Timer tells me that the direction of the market is down, I adjust the strategy of the portfolio accordingly. And the same is true to the upside.
The news stories that I read every day are useful in allowing me to interpret trends and to understand what investors are doing, but I wouldn’t ever use a piece of analysis or a prediction to go against what the Timer tells me.
Take a couple of stories that appeared last week, one about China and one about Brazil. The story about China was a report by the International Monetary Fund that the Chinese economy is strong enough for the IMF to raise its GDP growth forecasts for the year from 6.1% growth to 6.7%. That’s potentially good news, because it may encourage some big, risk-averse institutional investors to increase their exposure to Chinese stocks.
Yet in the same report, the IMF also issued a warning about China’s growing level of debt, forecasting that non-financial debt in the country could rise to as much as 300% of GDP within five years.
Accordingly, since I can’t figure out whether the increased GDP forecast will balance out the debt warning, I’m glad that all I have to look at is the chart.
Another piece of news was much more one-sided, and that’s the news of Brazil’s cancellation of its fiscal targets for 2017 to 2020. The problem is that the scandal that has caused Brazil’s president Michel Temer to be charged with taking bribes from a giant meat-packing company has destroyed his administration’s ability to undertake economic reforms.
Coming as it does after a string of scandals and criminal convictions that have embroiled the country’s two previous presidents, this is unfortunate indeed. Brazil’s government already has the heaviest debt burden—just over 73% of GDP—of any of Central and South America’s emerging countries, and the assumption is that the lack of reforms will inflate that debt quickly in the future.
There is no doubt that news headlines have the power to move stock markets, both up and down. Chaos in Washington, D.C., the confrontation in North Korea, Brexit negotiations and terrorist attacks all change how investors feel and their perception of the future. So it’s no surprise when a negative news story is cited as the reason for a market correction.
But it’s always good to remember that the reality represented in the chart is always more important than the “why” stories that seek to interpret that reality. Today, despite plenty of worries and sluggish action from the U.S. indexes, our Emerging Markets Timer is still bullish, so it’s best to remain constructive.
Featured Stock
A Unique Way to Play the Growth in Electric Vehicles
Sociedad Quimica y Minera de Chile (SQM)
There is an old (and harsh) market saying that says, in a war, don’t put your money on whoever you believe is going to win the war, but instead, invest in the arms supplier, who’s sure to make a profit no matter who comes out on top.
That’s the general theme with Sociedad Quimica y Minera de Chile (which we’ll just refer to as Sociedad for ease), a good-sized ($2 billion in revenue during the past 12 months) Chilean raw materials and chemicals producer. The company has its hands in many pies, including potassium products for fertilizers and plant nutrition (a combined 27% of gross profit), iodine products used in everything from LCD screens to sanitizers (6% of gross profit), and industrial chemicals that are used in glass, metal, water treatment and more (7% of gross profit). Trends in these businesses are solid, but not spectacular.
The real attraction is Sociedad’s leading global position in lithium production, both in terms of output and (according to the company) cost. Lithium has traditionally been used in a variety of products like ceramics, aluminum and rechargeable batteries. That last part is the big draw—while demand from other sources should remain relatively steady, the boom in electric vehicle production (and the batteries they’ll use) should hike demand for lithium in a big way going forward.
According to many forecasts, lithium demand should increase steadily for many years. Demand was around 200,000 tons in 2015, but most expect that figure to at least double by 2025 as electric car production ramps. Sociedad’s management sees demand up 14% this year and 10% to 12% annually for many years after that, reaching 500,000 tons by 2025.
Not surprisingly, then, the firm is aiming to ramp its output to take advantage of the opportunity. Sociedad currently has capacity of 48,000 tons per year, mostly from its operations in Chile, which should increase to 63,000 tons by the second half of next year due to expansions that will soon be underway. Beyond that, the company is making some aggressive moves so that it will be ready as demand increases.
First, it’s part of a joint venture at a mine in Argentina that’s in the process of being built out; initial production is expected in 2019, with eventual capacity of around 50,000 tons.
And second, it recently agreed to buy a 50% stake in an Australian lithium project for $30 million (and with a promise to fund $80 million in development costs). Some production is expected within a couple of years, with output expected to reach 40,000 tons by 2021.
Of course, other players in the industry are also busy expanding production, which always raises the specter of overcapacity—there’s nothing proprietary about lithium, so if supply ramps quickly (or if electric car demand fades), prices could fall. In fact, given the history of most commodity-based sectors, overcapacity is probably a sure bet at some point.
But that time is likely many years from now given the lead times it takes to get a project up and running, as well as the likely increase in electric car production during the next few years. Indeed, Sociedad raised prices nearly 80% last year due to tight supply, and there’s been no retreat this year—in the first quarter, the firm’s lithium sales volumes grew 12% while revenues surged 98%. That helped Sociedad’s EBITDA (a measure of cash flow) rise 39%. Those trends continued in the just-reported second quarter, where lithium sales were up 33%, thanks mainly to higher prices.
One other thing to note is that SQM has a lot of big owners—Potash Corp., Pampa Group and Bank of New York all own huge chunks of Sociedad. We don’t really see that as a hindrance, but it’s always possible that one of them decides to let go of some of their shares if the stock makes a great run.
Right now, though, there’s no question buyers are in control. SQM went over the falls in a big way during the commodity stock bear market in 2015 and early 2016, falling from 32 to 12. But it’s been in a solid, relatively steady uptrend ever since, poking above 30 late last year and rising to 37 in April.
That was followed by a three-month, double bottom base, and since late-June, SQM has been a star performer, rising persistently into the low 40s and, after some shaking and baking, has surged to new highs following its quarterly report this morning. Given the recent run-up, we advise starting with a half position. BUY A HALF.
Sociedad Química y Minera de Chile S.A. (SQM 46)
El Trovador 4285
6th Floor
Santiago, Chile
56 22 425 2000
http://www.sqm.com
Model Portfolio
Invested 80% Cash 20%
Updates
U.S. indexes have been choppy-to-down during the past few weeks; net-net, many of them haven’t made much progress in a couple of months. However, emerging market stocks remain in good shape—our EM Timer is still positive, and in fact, the iShares EM Fund (EEM) has hit new closing highs this week.
That doesn’t mean the situation isn’t tricky—some EM stocks have hit potholes on earnings—but with the intermediate-term trend still pointed up, we’re staying mostly invested and taking new positions as opportunities arise.
We have one change in tonight’s issue: NetEase (NTES) moves to Sell.
Alibaba (BABA) has gone vertical since reporting earnings a week ago, which is great to see, and long-term, there’s likely more to come—analysts have ratcheted up their earnings estimates since the report and are now looking for 44% growth this year and 31% next. That said, BABA is extended to the upside and is likely due for a rest (or at least a shakeout). If you own some, just sit tight, but for new buyers, try to get in on dips. BUY.
Autohome (ATHM) is another one of our holdings that has shot ahead since reporting earnings recently, ripping from 50 to 65 in just a couple of weeks! Business is obviously going gangbusters (earnings are expected to rise 34% this year), and chart-wise, we’re intrigued by (a) the stock’s calm, tight trading for many weeks pre-earnings, and (b) that the recent liftoff finally pushed the stock to new all-time highs, above its 2014-2015 nadir. If you want in, start small and aim for pullbacks of two or three points. BUY.
In July, many stocks that gapped up on earnings fell flat on their face soon after. But recently, many earnings gaps have held up well, and Baidu (BIDU) is a good example—shares have traded in a reasonable range for all of August after surging near the end of last month. Fundamentally, the company is throwing in the towel on its takeout delivery service, but it should fetch north of $2 billion and allow Baidu to focus on other, more profitable ventures. If you don’t own BIDU, you can pick up some shares here. BUY.
China Lodging Group (HTHT) has tacked on another few points since last week’s excellent earnings report, hitting new highs in the process. After a few quarters of mild growth (sales up in the single digits), China Lodging’s top line grew 18% last quarter and analysts see earnings growth accelerating in a big way going forward (up 43% this year and 37% next). As we’ve written many times, HTHT isn’t early in its overall run, and the stock’s recent surge leaves it well above its intermediate (22% above its 50-day line) and longer-term (65% above its 200-day line!) moving averages. That doesn’t mean the stock can’t go higher, just be sure to keep your feet on the ground. New buyers should keep it small and aim for pullbacks of a few points. BUY.
Despite the up-down-up-down action by most U.S. financial stocks, HDFC Bank (HDB) remains in good shape, with a normal pullback and consolidation during the past three weeks. Analysts see continued growth going forward (25% this year, 24% next), buoyed by India’s recent base-broadening tax reform, which should bolster economic growth. On the downside, a break into the high 80s would be a yellow flag, but right here, we’re staying on Buy. BUY.
JD.com (JD) has bounced a bit in recent days, but the chart continues to look damaged—the seven straight days of big-volume declines before and after earnings is a strong sign that big investors are unloading shares. We think there will be better performers going forward. SOLD.
NetEase (NTES) fell sharply on earnings two weeks ago but did hold some support near 270 in the days that followed, which was enough for us to hold on. But shares couldn’t even get off their knees after the drop, even as emerging market stocks rallied, and now they’re coming under renewed selling pressure. With the stock cracking support and a loss, we’re going to sell our half position and cut the loss. SELL.
TAL Education (TAL) is another hot stock, soaring from around 20 (split-adjusted) to a recent peak north of 32 in less than two months! The story, numbers and chart all look great, but the same caveats that apply to HTHT also apply here—TAL is relatively late stage and extended to the upside (25% above its 50-day line, 71% above its 200-day line), so keep new positions small and look to buy on dips. BUY A HALF.
Tencent Holdings (TCEHY) remains a big-cap leader of China’s advance, right up there with Alibaba. Despite trading over-the-counter, we’re impressed by the stock’s recent surge in volume; average daily volume was around 700,000 shares in March, but today totals nearly two million. Sit tight if you own some, and if you don’t, you can pick up some shares here or on dips of a point or two. BUY.
To this point, YY Inc. (YY) has handled its large share offering well, initially dipping to nearly 70 but crawling higher in recent days. That said, we’d prefer to see more strength before advising new buying here, but with YY still hanging around its 25-day moving average, we certainly can’t say the chart has suffered any major damage. If you own some, hang on. 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 IS SCHEDULED FOR September 7, 2017
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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 2017. 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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