The emerging market sector remains in a downtrend as we patiently await the buyers to arrive. When they do, we fully expect a profitable, sustained uptrend given the persistent decline this year, but until that happens, it’s best to stay mostly on the sideline.
There is one area in the EM world that’s doing well, though, and in tonight’s issue, our new recommendation is a mega-cap stock from that country. It’s a familiar name, is part of a resilient sector and has huge turnaround potential.
Cabot Emerging Markets Investor 670
[premium_html_toc post_id="162152"]
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 continues to trend lower, keeping us in a defensive stance, safe from most of the damage. The iShares EM Fund (EEM) was showing a little resilience in September, but the global selloff so far in October has pulled the fund to new yearly lows. With EEM well below both its moving averages, the intermediate-term trend remains down.
As we write on page 1, the decline in emerging market stocks is fairly ripe, having started back in January and totaling 25% so far, with many individual stocks in far worse shape. Thus, now’s not the time to stick your head in the sand—there will be another uptrend, but until it gets underway, it’s best to hold plenty of cash.
Bring a Book. Pack a Lunch.
The tariff wars and rising interest rates are beginning to have a measurable effect on the economies of the world, with emerging economies taking the biggest hit. The International Monetary Fund has just lowered its forecasts for global growth this year to 3.7%, which is down from its April estimate of 3.9%.
The IMF sees the changes in two major regional trade arrangements (NAFTA and Brexit) and the U.S. tariffs on Chinese imports as potential disruptions of global supply chains. And while the global growth forecast is down just two-tenths of a percent, the effect on emerging markets and frontier economies is likely to be harsher.
The other factor kicking emerging markets in the shins has been the strength of the U.S. dollar, a factor that raises the price of imports and puts pressure on emerging manufacturers and exporters. Turkey and Argentina have been especially hard hit by currency drops.
Since the middle of the year, the combined economic pressure on emerging economies has been a perfect cold-water bath for investors, who have been pulling money out of emerging-market ETFs at the fastest rate since January 2014. And coupled with the risk-off sentiment that has recently turned U.S. investors away from growth stocks, especially the tech stocks that have powered so much of the market’s gain over the past couple of years, the effect has been powerful.
There are a few bright spots, though. Investors have taken a liking to Brazilian stocks in the wake of the first round of that country’s presidential election. Investors like the idea that Jair Bolsonaro, a far-right, ex-Army captain, is in the lead, having received almost half of the votes. Bolsonaro’s opponent in the final round of voting is Fernando Haddad, whose Workers’ Party has been hit by a graft scandal, and who took just 29% of the first-round votes. In turbulent times, investors see a strong leader as a good hedge against uncertainty, and Bolsonaro has promised to put a former banker in charge of Brazil’s economic policy. The iShares Brazil ETF (EWZ) has shown some real strength since the September election and some Brazilian ADRs are looking attractive. Here’s a three-month chart of EWZ.
But Brazil is still the exception. Since the beginning of the year, iShares EM Fund (EEM) has been going downstairs like a Slinky, staging minor rallies but continuing to produce an unbroken string of lower highs, with a similar record of lower lows broken only by a March/April flat patch that tightened up a little. Here’s a chart showing EEM’s determined slide since the beginning of 2018.
The bottom line is that we have been in a protracted spell of underperformance by emerging market stocks. I’m not predicting what comes next, because there’s nothing the market likes more than to make predictions, no matter how well supported and reasoned, look silly.
But I’m going to keep our cash level as high as necessary to stay away from the giant slalom course that is the emerging markets right now. And if I can sharp-shoot a winner that’s bucking the trend, so much the better. But the default setting is definitely cash until further notice.
Featured Stock
Sometimes the Obvious Choice is the Right Choice
Petrobras (PBR)
Recommending Petrobras (Petróleo Brasileiro S.A.), the Brazilian national oil company, isn’t exactly a rocket-science move. Oil prices hit their highest levels since 2014 in October, and even with their recent slip, are at a level to provide huge valuation premiums to owners of large oil reserves, which Petrobras has in spades.
The company is also continuing to emerge from the world-class corruption scandal that brought down at least two Brazilian presidents and enough politicians and businessmen to fill a medium-sized prison, which is exactly what happened to many of them. Things were so bad that the company still has an official “Petrobras Denouncement Channel” on its website where anyone can register charges of fraud, corruption, money laundering and the like. (If you have a taste for tales of bad behavior on a monumental scale, a visit to Wikipedia’s article on Operation Car Wash will provide you with a half-hour of entertaining reading and several links to follow.) The payment of a nearly $3 billion settlement of a U.S. class action suit earlier this year lifted a major liability from the company’s shoulders.
Petrobras has been benefiting from leadership that actually has the company’s profitability and shareholder value in mind. After four years of losses, the company has turned around its cost structure and is making capital expenditures aimed at improved exploration and drilling efforts that will pay dividends in the form of increased reserves. On top of the current reserves of well over 9.7 billion barrels of oil equivalents (BOE), further exploration and drilling of the company’s extensive offshore fields in Brazil, Africa and North America will be a long-term benefit.
Petrobras is a very big oil company, with a market cap of $96 billion, 13 refineries that can produce 1.8 million barrels of oil products per day, 8,200 service stations, nearly 5,000 miles of oil and gas pipelines and a growing string of biofuel plants, thermoelectric plants and wind energy joint ventures.
After four years of annual losses, the company has booked excellent earnings growth in the first two quarters of 2018—52% in Q1 and a whopping 1,900% jump in Q2. Revenue, which fell 6% in 2016 and 7% in 2017, grew by 5% in Q3 2017 and 7% in Q4 before remaining virtually unchanged in the first two quarters of this year. But the company’s 12.4% after tax profit margin in Q1 and 15.4% in the most recent quarter is the strongest performance ever. Analysts are looking for 75% earnings growth this year and 40% in 2019.
I had PBR in the portfolio from January through May, exiting the position after a national truckers’ strike in Brazil led the company to lower diesel prices by 10%. The stock dipped from 17 in mid-May to 9 a month later. (We sold around 13 for a near-breakeven trade). The stock’s rebound ran back to 13 in early August, but another slip later in that month pulled it back to just above 10. But once October began, the stock took off like a rocket. PBR is now trading at around 16, close to taking out its May highs.
PBR isn’t quite the value stock it was a month ago, but it makes up for that with a nice head of momentum. The stock’s 0.35% annual dividend yield isn’t a major consideration, but it’s another small plus.
With Brazilian stocks one of the only national markets making gains in the emerging markets universe, I’m confident that PBR represents a good risk/reward setup. But I will recommend taking just a half position until we get the broader emerging market’s momentum solidly behind us and a little profit cushion to work with. BUY A HALF.
Petrobras (PBR)
Av. República do Chile, Sala 1002 Centro
Rio de Janeiro, RJ 20031-912
Brazil
www.petrobras.com.br
Model Portfolio
Invested 35% Cash 65%
Updates
The correction continues among emerging market stocks, with the iShares EM Fund (EEM) sinking to new lows as the selling has spread to developed markets (including the U.S.). Thus, we remain in a highly defensive stance while we build up our watch list so we can grab winners early on during the next sustained uptrend.
Of course, when volatility picks up, so do the number of predictions, but we advise you largely to ignore that. Maybe stocks are near a low; maybe there’s another couple of months of pain before the tide turns. Either way, we have great conviction that, after what’s been a bearish year for EM stocks that has driven sentiment down to low levels, the next major uptrend will produce a ton of great winners as money flows back to the area.
For now, we remain patient, focusing mostly on building a watch list, nibbling here and there, holding plenty of cash and looking for signs that the selling pressure has exhausted itself.
Alibaba (BABA) has bounced decently during the past week, and if you’re looking for rays of light, BABA closed in the upper half of its trading range last week on its heaviest volume in more than two years, a sign of solid support. That said, this support comes after another leg down, and the stock is still well below its moving averages. We sold half our shares last week for a nice profit and will give our remaining position some room to maneuver as we see what earnings (due out November 2) bring. HOLD A HALF.
Baidu (BIDU) has a similar chart to BABA, with a leg down to start October but some weekly volume support last week. Fundamentally, NetEase’s music arm, of which Baidu is a backer, got another funding round recently, but that’s not enough to move the stock. Earnings, which are likely out around Halloween (give or take a couple of days), will be key—revenues are expected to rise 18% but earnings are likely to slip (though Baidu regularly tops estimates) due to heavy investments. Longer-term, it’s worth watching BIDU as some of these Chinese blue chips are likely to have big rebounds when the overall market environment improves. WATCH.
We sold our half position in Beigene (BGNE) last week, and the stock continues to languish, with zero ability to bounce in recent days. There should be better stocks to own during the next bull move. SOLD.
Bilibili (BILI) remains the best looking of the three recent IPOs we’re following—it’s actually etched multiple higher lows since reacting well to earnings in late August, including a bunch of solid up-volume clues. The most recent good news came earlier this month, when Tencent announced it would invest $318 million in BILI, or about 12% of the company. Of course, none of this guarantees anything, but so far, the stock’s action is a big plus, and the Tencent investment should only help investor perception. Earnings are likely due in mid to late November. WATCH.
Ecopetrol (EC) has pulled back this month, but unlike so many stocks, the dip looks normal, with EC trading above its 50-day line, and with the powerful early-September breakout holding firm. If oil prices continue to skid, there’s always a chance that EC gives up the ghost, but at this point the odds favor another leg up. We’re OK buying a half-sized position on this three-week retreat. BUY A HALF.
Huya Inc. (HUYA) is the worst looking of the three recent IPOs we’re following, with the stock bumping along to lower lows in recent weeks. That’s still not incredibly bad action—just in line with what the broad Chinese and emerging market sectors are doing. Signs of further competition in the Chinese streaming market haven’t helped the cause in recent days, though. We’re content to keep the stock on our watch list given its huge projected growth (57% revenue growth in 2019, earnings up 140%). Earnings are likely out in mid November. WATCH.
iQIYI (IQ) has also been dented this week on rumors of competition. The firm inked a deal with Viacom to produce and distribute the second season of Deer Run, an animated series aimed at preschool kids; the first season should air in 2020, with the goal of a long-running series after that. Back to IQ stock, our patience isn’t unlimited but we continue to advise holding a half position and waiting for support. HOLD A HALF.
RYB Education (RYB) took a quick dive last week as the market’s pressure was too much to bear. But, impressively, the stock bounced right back and is now hanging around the lower end of its months-long trading range. While there’s little question the Chinese economy is slowing, we continue to think education spending in that country will be resilient, and that RYB could be do very well in the next market upturn. A close below 18 would probably have us bailing, but if you want to nibble here with a tight stop, you can. BUY A HALF.
Vale (VALE) remains perched near its peak and has been under solid accumulation since the first half of September. The company’s iron ore output in Q3 rose 10.3% from a year ago and reached a record, with a lot of that high purity ore that’s in big demand from China and others. We’ll stay on Buy, though try to get in on dips of a few dimes. BUY.
WNS Holdings (WNS) is thrashing around its 200-day line, which is acceptable for now. But a big break from here would probably imply a deeper longer-term downtrend and consolidation, and have us dropping it from our coverage. Earnings are due out October 25, which will likely determine the stock’s next move. WATCH.
[premium_html_footer]
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 November 1, 2018
We appreciate your feedback on this issue. Follow the link below to complete our subscriber satisfaction survey: Go to: www.surveymonkey.com/chinasurvey
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 2018. 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.
[/premium_html_footer]