The general trend in emerging market stocks has gone from bad to worse, and we have responded by moving heavily into cash. And although this isn’t as much fun as picking out the big winners from among a stampeding herd of strong stocks, it’s the price we have to pay to play profitably in a volatile market. Today we’re featuring a relatively conservative stock that sports strong fundamentals and a tidy dividend.
Cabot Emerging Markets Investor 667
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.
Our Emerging Markets Timer remains firmly negative, with all recent rallies failing to gain momentum before the sellers show up. The latest rally in the iShares EM Fund (EEM) actually took it above its (declining) 50-day line, but most of that move has been erased amidst a rush to the exits this week. With the trend clearly down, we continue to advise a defensive posture.
That said, it’s important not to stick your head in the sand—when the turn comes, it should be very profitable given the recent meltdown, and EEM itself has actually found support in the 41 to 42 area in recent months. But for now, preserving capital is key.
The Duck’s Back
Emerging markets are mired in a selloff that’s been going on since January. That’s not unreasonable after an advance that ran for two full years, but it’s still trying.
The situation for Chinese ADRs is similar, although the downtrend began in June. And the China correction is all the more frustrating because it’s absolutely rational; investors who avoid putting money to work in China because there’s a trade war raging with the U.S. are probably doing exactly the right thing.
We have handled this correction the way good growth investors handle all such moves, by tightening the stops on the stocks in our portfolio and moving progressively into a heavier cash position. The only way to enjoy a downtrend is to be watching it from the sidelines, and our 75% cash position gives us plenty of insulation from big selling waves.
While all emerging market stocks are under pressure, Chinese stocks have been especially hard hit. Starting about two months ago, Chinese tech stocks began underperforming their U.S. counterparts, a move that shows no sign of being over. Alibaba (BABA), which we have on Hold in the portfolio, is currently the most heavily shorted stock in the world (in dollar terms), with $18 billion of bets against it.
In addition to trade-war worries, investors are concerned about heavy declines in foreign exchange values of many emerging market currencies. The Indian rupee is at an all-time low, the South African rand, the South Korean won, Russian ruble and the Saudi Arabian and Indonesian currencies are all under heavy pressure from U.S. interest rate hikes and the strengthening U.S. dollar.
As some analysts are pointing out, we’re reaching a point where the correction in EM stocks is no longer about fundamentals and market realities. Increasingly, the focus is on possible contagion, a situation in which the selloff gains momentum and investors fuel the decline by cashing out of their EM holdings.
The really good news for Cabot Emerging Markets Investor is that we can shed all this bad news like water off a duck’s back. What we don’t own, we don’t moan about.
Sure, it would be great to discover an outlier stock that’s bucking the odds and heading higher. But with the wind and tides heading in the wrong direction, that’s unlikely.
Fortunately, there are positive signs about some emerging market economies. India has taken China’s place as the fastest-growing major economy in the world, with an 8.2% hike in GDP growth in the second quarter. That’s a nice bump from Q1’s 7.7% growth. (That’s also a solid beat of expectations, as economists expected just 7.6% growth.)
India is getting a definite boost from being firmly out of the line of fire in global trade wars, with a strong manufacturing sector and a domestically driven economy.
China’s 6.7% Q2 growth puts it solidly in second place, with Indonesia taking the third spot with 5.3% GDP growth. Mexico is the next-strongest EM country with 2.6% growth.
Eventually, when the trade wars end or are fully priced into investors’ expectations, emerging market stocks will bounce back and present some huge opportunities given the big declines this year. And we’ll be ready, having used our cash umbrella to avoid the downpour.
Colombia-based Ecopetrol is a fairly conventional integrated oil & gas explorer, producer, refiner and transporter with global reach. The company’s exploration footprint is mostly Colombian onshore, but the company also has interests in northern Chile and (increasingly) offshore Colombia.
Ecopetrol (the name was shortened in 2003 from Empresa Colombiana de Petroleos) is still a state-run company, but it has a few catalysts for change that are working strongly in its favor.
The first factor is the rebound in the price of crude oil itself. When crude was trading below 30 in January 2016, Ecopetrol’s reserves were worth very little. But prices hit 66 in January 2018 and have now advanced to over 70, boosting the company’s net worth and its revenues.
The second factor working in Ecopetrol’s favor is the turnaround in the company’s exploration success. In 2017, the company made the most important discovery in a long time, successfully drilling a new offshore gas discovery called Gorgon-1. This essentially adds a new province to the company’s operations: offshore Colombian Caribbean basin. Of the 12 wells planned for drilling in 2018, five have been drilled and two have been successful. Evaluation of the size of the offshore discovery will take years, but it’s definitely a plus for the company.
The third factor aiding Ecopetrol is increased capacity at its Cartagena and Barrancabermeja refineries where throughput has increased by 13% and 9%, respectively. The refineries have also increased the percentage of Colombian crude in their feedstock to 79%, up from 42% a year ago.
Ecopetrol is also revving up its acquisition and capital expenditure programs with an eye to expanding into additional markets (including the U.S.) and building its reserves. A 15% increase in upstream investment from the first half of 2017 is expected to boost proven reserves, with 96% of exploration investment targeted at Colombia itself. Rig counts are increasing and 74% of capex is targeted at production.
Management has also increased cost-reduction efforts. The company’s pipeline additions have lowered the cost of sales by 3% and increased the volume of transported product (both crude and refined) slightly, with more capacity improvements ahead.
The bottom line is that Ecopetrol has turned around both its revenue growth and earnings per share trends. The company lost money in 2015, but has now booked seven consecutive quarters of triple-digit earnings growth, with analysts looking for an 80% bump in 2018. Revenue pulled out of four years of declines in 2017 with a 15% increase, and the company Q2 report featured a 34% jump in revenue and a 20.7% after-tax profit margin, its strongest ever.
EC went over the falls for three years from January 2013 to January 2015, falling from a high of 52 to a low of 5. The stock rebounded to 10 in April 2016 and put in a long basing structure under resistance at 10 that ended when the stock broke out in Q4 2017. EC ran to 22 in April 2018 and has been trading sideways despite the pressure on emerging market stocks. That stability, plus a dividend with a forward 2.7% annual yield. We don’t expect EC to be a rocket, but it’s a solid investment that will be a good buy when it finally breaks out above 22. We’ll just watch it for now. WATCH.
Carrera 13 No. 36-24
Invested 25% Cash 75%
Continuing fears of slowing growth in emerging market economies, currency declines and uncertainties about trade spats (the U.S. is set to impose another round of tariffs on Chinese goods) have led to a new wave of selling pressure in EM stocks this week. Both the iShares EM Fund (EEM) and the Golden Dragon Fund (PGJ) of U.S.-traded Chinese shares remain in downtrends, so we’re staying in our storm cellar.
That said, we want to emphasize now isn’t the time for gloom and doom. Sure, this decline could continue for a while longer, or possibly accelerate if some bad news hits. That’s why we’re heavily in cash! But at this point, the horrid performance of EM stocks is well known and obvious, and money flows out of the sector have been quite large.
Said another way, the sentiment pendulum has swung very far to the pessimistic side that once the buyers return, there will be tons of great opportunities. We’ve seen this play out countless times in the past, and there’s no reason to believe this time won’t be different.
With that out of the way, we continue to trade off the here and now—and with the trend pointed down, we’re trimming a bit further this week as stocks crack support.
Alibaba (BABA) has sunk back to the lows of its basing pattern amidst the sharp selloff in Chinese stocks. Obviously, the macro environment for Chinese stocks is what’s driving BABA now, though the market’s patience is running thin with the company’s massive investment spree that, while producing outstanding revenue growth (north of 61% each of the past four quarters), is crimping earnings (up just 3% in Q2 and expected to actually decline in Q3). That said, we still have high hopes for BABA down the road; there aren’t many big, liquid stocks that are growing this fast. We won’t hold on forever if the stock keeps declining, but given that it’s hanging around support, we’re giving BABA a chance. HOLD.
BeiGene (BGNE) took a hit yesterday but, as opposed to the vast majority of EM stocks, has basically been in a sideways range since mid June. The company continues to make progress on its pipeline—China has accepted a new drug application for one of BeiGene’s cancer treatments, and it struck a deal with SpringWorks to collaboratively work on a couple of clinical trials for new drug candidates. With a good-looking range and support, we’re OK buying a half-sized position of BGNE here. BUY A HALF.
Bilibili (BILI) is the first of three recent IPOs we’re either watching or (in the case of IQ) holding a small position in. BILI’s chart is the weakest overall, having given up all of its June moonshot. But looking ahead, given the positive reaction to earnings last week and the general lack of selling volume since mid July, we have high hopes. Keep it on your watch list. WATCH.
Huya Inc. (HUYA) has pulled back in recent days, but interestingly, it’s remained above its post-earnings low from three weeks ago, a small ray of light. The firm has been all quiet on the news front since releasing its quarterly results. We’re OK keeping HUYA on the watch list given its big prior run in June and the rapid expected sales (up 58% next year) and earnings (more than doubling to 55 cents per share) growth. WATCH.
iQIYI (IQ) looks similar to HUYA, with a low around 25 in mid August and, so far, the stock is holding above that level. As with BABA, we won’t simply hold and hope if IQ continues to move lower, but given the big story, growth and recently resilient chart, we’re sitting tight with our half position. HOLD A HALF.
We sold JD.com (JD) last week and we’re glad we did, as the stock has imploded with the weak Chinese market and accusations of impropriety from its CEO. Even if the market found its footing, it looks like JD will need a long time to repair the damage. SOLD.
RYB Education (RYB) continues to chop in a sideways-to-down range, holding support in the 19 area. We think the education sector isn’t overly dependent on the economy, so the trade war fears and slightly slowing Chinese growth shouldn’t affect the company’s bottom line much. BUY A HALF.
WNS Holdings (WNS) remains relatively impervious to the market’s volatility, as the stock has basically treaded water during the past five weeks. Depending on how the stock acts, WNS could be a nice conservative growth stock to own once the environment turns more positive, and would give us a foot in the door of India, the fastest-growing emerging economy at this time. WATCH.
Send questions or comments to firstname.lastname@example.org.
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 September 20, 2018
We appreciate your feedback on this issue. Follow the link below to complete our subscriber satisfaction survey: Go to: www.surveymonkey.com/chinasurvey