In this week’s issue, there’s good news about the portfolio’s performance in 2017 and great news about TAL Education. There’s also a new recommendation for a big energy company that’s emerging from the cloud of an enormous national scandal.
Cabot Emerging Markets Investor 651
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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.
Buying panic! Our Emerging Markets Timer remains firmly bullish as the iShares EM Fund (EEM) hit new highs at the end of last year and has gone straight up with the market so far in 2018. With EEM well above its lower (50-day) moving average, the intermediate-term trend is clearly up.
In the short-term, emerging market stocks could be vulnerable to pullbacks and shakeouts, especially as earnings season progresses. But the persistence and power of the recent upmove bodes well down the road, so you should continue to hold your winners and remain heavily invested.
Staying Balanced
Here’s what responsible travelers do. When they check into a hotel, they look at the emergency exit map on the back of the door. They may even walk through the distance from the door to the exit stairwell.
When they get on a cruise ship, they do the shipboard equivalent, getting familiar with the escape routes, life vest availability and the location of lifeboats.
There are a ton of other little precautions that careful travelers practice, like keeping xeroxes of their passports in their suitcases, letting their credit card companies know that they will be outside their usual ambit, packing Immodium (just in case). And so on.
Of course it’s possible to overdo caution, and we all know people who are so focused on possible bad things that they take the joy out of travel (and most other things).
For growth investors in a long-running bull market, finding the balance between caution and enthusiasm can drive a person nuts.
And let me say right here that I realize that I’m habitually talking out of both sides of my mouth. And so is just about every responsible growth investment advisor I know.
I point out constantly that it’s a bull market and that you should be heavily invested in great growth stocks.
But I also harp on the likelihood (certainty, actually) that there will inevitably be some kind of correction/bear market event in the future and that you should also be prepared for that eventuality.
The responsible growth advisor’s job is to give you the confidence you need to put money to work when the market is doing well. But it’s also an advisor’s job to keep you from getting so confident that you fail to see when a bull run is ending and it’s time to sell.
As we head into earnings season for our stocks (three firm reporting dates so far: TAL Education this morning, 1/25; Alibaba before the open on 2/1; and Grupo Supervielle after the close on 2/19), we can certainly look in the rear-view mirror at a great year.
In 2017, the portfolio gained 55.6%. Emerging markets acted exactly as they’re supposed to, with higher volatility producing bigger swings both up and down. And the portfolio did well by riding winners higher and keeping losses small, just like the growth investing playbook says.
For comparison purposes, during the same calendar year, iShares MSCI Emerging Markets ETF (EEM), which is the basis of the Cabot Emerging Markets Timer, was up 36.7%.
Here’s an explanation of how I calculated the returns.
Based on a nominal portfolio of $100,000. Initial prices for stocks in the portfolio at the beginning of the year are as of the close on December 30, 2016. Stocks added during the year were priced by taking the average of their high and low prices on the day after their recommendation was published. Values for stocks sold during the year were priced at the average of their high and low prices on the day after the sell recommendation.
Stocks in the portfolio at the end of the year were priced as of their close on December 29, 2017. These numbers reflect initial half or full positions and partial sells during the year.
I’m looking forward to another year of challenges and opportunities.
Featured Stock
Out of the Shadow of Scandal
Petrobras (PBR)
On the one hand, Petrobras, the Brazilian national oil company, is a very simple story: the price of oil is up to over $65 per barrel for the first time in four years and Petrobras owns a huge amount of oil.
On the other hand, Petrobras is a company that’s finally emerging from what’s possibly the biggest, most dramatic national corruption scandal anyone has ever seen. The story of the corruption (and the dramatic details of how it was discovered and rooted out in “Operation Car Wash”) is worthy of a Hollywood blockbuster, but I’ll just sketch it in and give you a link to the whole saga.
Petrobras executives oversaw an operation that systematically overpaid on contracts for construction, drilling equipment, refineries and drilling ships. The companies that got the contracts kicked back money to slush funds that were used to finance political campaigns. With the entire political power structure on the take, investigation and prosecution was virtually impossible. But not completely.
Two Brazilian presidents were toppled in the scandal along with dozens of other politicians, corporate executives and countless underlings, many of whom are in jail and likely to stay there for a while.
The scandal isn’t over; Brazil’s current president, Michel Temer, is under suspicion and the investigation into the web of corruption—said to have involved about $2 billion in bribes—is continuing. But Petrobras just signed an agreement in principle to pay $2.95 billion to settle a class action lawsuit in the U.S. And the company now appears free of the corrupt obligation to finance an entire political network.
What we’re left with is an integrated oil & gas company with a market cap of $85 billion, reduced operating costs, lower leverage, outstanding technical expertise in offshore drilling and production, and reserves of oil, natural gas and condensates of 10.5 billion barrels in Brazil, Africa and North America.
There is still significant risk inherent in the Petrobras situation. Just this month, Fitch Ratings affirmed the company’s BB debt rating due to political and economic risk (Brazil is, understandably, in a recession). Some analysts think that the ongoing scandal makes Brazil vulnerable to political extremism or a military coup.
But the chart for the company’s stock tells a different story. From its post-Great Recession peak at 49 in late 2009, PBR declined steadily for years, sinking as low as 2.7 in January 2016. The stock rallied to 12.5 in October 2016, then headed sideways, falling to support at 7.6 in mid-2017 and inching back to a high at 11 last November and ending the year at 10. But since the New Year, PBR has been a rocket, with only one correction that lasted two days. The stock has a 14-month base to build on and investors loved the January 24 news that the company’s CEO, Pedro Parente, has said he might stick with the company after the next Brazilian elections. PBR gapped up to 13 on a huge volume spike after that announcement.
The bottom line is that we have a big energy company with big reserves coming out of a big scandal—and we have a sector that’s been on its back for a couple of years showing definitive signs that a new uptrend is underway. Analysts are calling for Petrobras’ earnings to pop higher by 74% in 2018 and the stock usually pays a nice dividend (although the payment hasn’t been approved for 2018, the trailing yield was 2.44%). If you want to read the story of Operation Car Wash, I recommend this link: click here.
The portfolio will buy a half position in PBR tomorrow, and I recommend that you do the same. BUY A HALF.
Petrobras (PBR 13)
Av. Republica do Chile, Centro
Rio de Janeiro, RJ 20031-912
Brazil
http://www.petrobras.com.br
Model Portfolio
Invested 100% Cash 0%
Updates
Stocks’ amazing run continues, with the emerging markets sector one of the strongest areas of the entire market. Our Emerging Markets Timer remains clearly bullish, so we’re sticking with a fully invested position.
Obviously, many stocks are extended to the upside here, which increases short-term risk of a retreat, especially with earnings season coming up for most of our stocks. Even so, that doesn’t mean you should be selling shares left and right—you’re better off following the trend, cutting loose any stocks that break but (most importantly) holding those that continue to act well, giving them a chance to turn into even larger winners.
That doesn’t mean you shouldn’t do any selling—anything that decisively cracks should be sold, and we’re working diligently to focus on the strongest situations and not get the portfolio too big for its britches. With that in mind, we’re going to book partial profits in Grupo Supervielle by selling half our shares. We’re also dropping coverage in Jupai for now, given our other stronger stocks.
58.com (WUBA) remains in good shape, as it’s held most of its big-volume, early-January gains. There’s no set date on earnings, but investors think the numbers will be good as e-commerce revs up in China and Asia in general—analysts expect earnings of 29 cents per share (up from a loss a year ago) and see a 62% earnings gain (to $2.40 per share) for 2018 as a whole. We’ll stay on Buy a Half. BUY A HALF.
Alibaba (BABA) has started to come to life, with the stock moving to new price highs this week on very impressive volume. We remain optimistic the next major move is up, but we’re also hesitant to go back to Buy here because (a) the stock’s relative performance (RP) line is still basically sideways, and (b) BABA will report earnings on February 1. If you don’t own any and want to take a small position here, we won’t argue. But officially, we’ll stay on Hold and see how this attempted breakout goes, along with next week’s reaction to earnings. Today’s news that the company inked a deal with Kroger is intriguing, but didn’t move the stock much. HOLD.
Autohome’s (ATHM) action is very encouraging—the four-and-a-half month base, breakout on the first trading day of the year and persistent follow-through since is how many big winners look early in their run. We’ll stay on Buy, though right now, it’s probably best to either keep new positions small or aim for dips of two or three points. Earnings are likely out near the end of February. BUY.
Baidu (BIDU) remains noisy on the news front, with management talking about more deals in the video content space this year (the company owns iQiyi, a video subscription service with about 400 million users) and looking for a whopping $2 billion investment in its financial division (which includes its mobile payment system) that had a valuation of less than $3 billion when the last funding round was completed. As for the stock, it’s still in the middle of its three-month range, though it’s shown some positive volume clues this month. We sold half our shares a couple of weeks ago, and will ride the rest into earnings (likely out in late February). HOLD A HALF.
China Lodging Group (HTHT) hit a new high on the first trading day of the year and has been chopping around since. We view that as normal action given the strong December run, with the recent dip toward the 25-day line (now near 150 and rising) likely marking a solid entry point. Earnings aren’t likely to be released for more than a month, but the company’s mid-January business update (90 new hotels opened, a 13% increase in the average room rate and a slight tick up in occupancy to 86%) all bode well. Analysts see earnings rising 43% this year. You can buy a half position here if you’re not yet in. BUY A HALF.
GDS Holdings (GDS) has been a wild child, but the action is superb, with the stock’s share offering-driven shakeout to its 50-day line last week giving way to a huge-volume rally to new highs. We expect continued volatility, but we’re aiming to give the stock room to breathe given our profit cushion. Fundamentally, the firm’s straightforward story (the leading carrier-neutral data center operator) should lead to years of rapid growth—it could be another Equinix of sorts. Try to buy on dips of a couple of points. BUY.
Grupo Supervielle (SUPV) continues to act well, though we’re going to be proactive here and book some partial profits. Why? Mostly because (a) we have a good profit, having bought it back around 23, but also (b) the stock has been running without any real correction (though there was one shakeout in November) since it broke out in mid-August, more than five months ago. We’ll sell half here, book some profits, and then aim to ride our remaining shares for a longer-term gain. SELL HALF, HOLD THE REST.
We’re still keeping an eye on Jupai Holdings (JP), but with our portfolio filled to the brim, we’re going to stop following up on it until we decide to pull the trigger. The stock remains in the middle of a deep, loose base—not completely abnormal, but not nearly as strong as most emerging market stocks. DROP.
Melco Resorts and Entertainment (MLCO) continues in its two-step-forward, one-step-back advance, with this week’s dip to the 25-day moving average providing an entry point. Melco’s peer Wynn Resorts reported a great quarter earlier this week (and also said January was off to a good start), which augurs well. We’ll stay on Buy. BUY.
TAL Education (TAL) is still building a base, though this morning’s earnings release might be the tonic that attracts the buyers. In the quarter ending November, revenues rose 66%, bolstered by an 85% jump in student enrollments (to 1.54 million), resulting in earnings of nine cents per share, which was three cents above expectations. The current quarter outlook for a 51% gain in revenues was also a plus. Shares rose sharply on the news, up more than 17% at one point, but what the gain really does is restore the correction that TAL suffered from January 11 through January 16. This is a very welcome and hopeful move, but we will keep our recommendation to Hold a Half until TAL shows evidence that it’s ready to make a run at its October high at 36. HOLD A HALF.
Tencent Holdings (TCEHY) continues to chug higher, climbing to new price highs above 60 this week. The company is well known in part for its popular WeChat messaging app, but the firm isn’t resting on its success—Tencent is backing a so-called “super app” called Meituan (which allows everything from restaurant booking and ordering, to paying your tab, to hailing a cab and more) that is gaining size quickly (four million merchants are customers) and already has a private valuation of $30 billion! Tencent also made waves a few weeks back with a $600 million investment in Vipshop, a leading Chinese online retail and flash sale outfit. Back to the stock, TCEHY isn’t early in its overall advance, but there’s no arguing with the uptrend—you can buy here or on dips of a point or so. BUY.
We went back to Buy on Weibo (WB) in last week’s update and we’re staying there today, as the stock is still perched near its highs after a great three-week run to start the year. The pause of the past couple of days can be used to enter. BUY.
YY Inc. (YY) remains one of the strongest Chinese stocks that few investors have heard of. But YY is attracting some positive institutional attention due not only to the growth of its core business, but also thanks to bullishness about a potential spinoff of its live-streaming and e-sports platforms. We like YY’s power, but as with most stocks, you should either start small or aim for dips of a few points. BUY.
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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 February 8, 2018
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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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