Right Where We Want Them

by Paul Goodwin on December 18, 2014

This is an excerpt from Cabot China & Emerging Markets Report, which seeks to capitalize on the big boom in China and other emerging market countries. Editor Paul Goodwin, Cabot’s international investing guru, provides your passport to profits.

This is one of those “bad news/good news” moments you read about. The bad news is obvious. Russia is in a recession, the ruble is at all-time lows and the country’s central bank just raised its interest rates from 10.5% to 17%. Plus, there is evidence that the country is being run by a guy whose global ambitions are more important than the state of his domestic economy.

China has slipped into a slower growth mode than expected and the most-recent purchasing manager’s index (PMI), which indicates the growth of the manufacturing sector, came in below 50, showing that manufacturing is shrinking. (In fact, the PMI came in at 49.5, while analysts were predicting 49.8, so the number was doubly disappointing.)

India, as measured by iShares MSCI India Fund (INDA), gapped down seven out of eight trading sessions, plummeting from above 32 to below 29.

So, if that’s the bad news, what’s the good news?

The good news is that our portfolio is 45% in cash, and may get more heavily into cash if the market continues to stumble after the current bounce. Most of our remaining stocks are on hold.

That might not seem like good news for an advisory whose stated aim is to find the strongest stocks in the emerging markets universe for you to buy.

If that seems like a paradox to you, just think about two opportunities. The first is to buy into a market that’s been in a strong uptrend for months. Prices have been soaring and more and more investors are jumping in. The second opportunity is being on the sidelines while investors are discouraged and markets are mired in a long period of trendless action.

The first opportunity is fun, but runs the risk of jumping in near a top and riding the winners back down. The second opportunity requires a little patience, but the upside potential is enormous, especially if you can determine when the negative market momentum turns positive again, and if you can identify the leaders early in their advances.

Don’t take this to mean that we prefer to have emerging markets in downtrends. That’s certainly not the case.

But the Golden Dragon ETF, which tracks the Chinese ADRs that are a large part of our investment universe, has been bouncing up and down with little net progress since October 2013. There have been some strong upsurges during the 14 months since then that have allowed us to make good money. (Cabot China & Emerging Markets Report is still rated 10th among all investment advisories for the past year.)

But our profits have come from good stock picking, not from a broad movement fueled by broad advances that lifted the whole field.

If it takes a harsher correction to reset investors’ perceptions of the value of emerging markets stocks, now looks like a good time for it. The portfolio is properly positioned to weather such a move.

On another topic, we attended the Financial Times’ Frontier Markets Summit in New York City on December 10, listening to presentations from panels of experts on global economics, investment banking, social and economic development and foreign policy.

The gist of the meeting can be summed up in one word: opportunity.

The frontier markets face huge challenges in developing infrastructure, achieving stable governance and avoiding the “cheap labor and commodities” trap that allows developed nations to exploit resources without letting the benefits flow to the country itself.

Practically, there aren’t many investible opportunities for individual investors at this point, though we do keep an eye on the iShares Frontier 100 Fund (FM) for fun. Investors with big bankrolls can partner with companies to open up frontier markets. But it will likely be a few years before indigenous companies are ready to tap U.S. capital markets by coming public here. Nigeria and Ghana in Africa, Yemen in the Middle East and Vietnam in Asia are the likely leaders in development of all kinds.

A researcher and writer for over 30 years, Paul Goodwin has been a member of the Cabot investment team and chief analyst of Cabot China & Emerging Markets Report since 2005.

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