Branching Out

It’s always worth paying attention when markets diverge. A little research into why one country, sector or industry is outperforming another will often yield useful information.

Right now, we have a situation in iShares MSCI Emerging Markets ETF (EEM), the broad emerging markets index we use to power our Emerging Markets Timer. The timer has parted ways with PowerShares Golden Dragon Halter USX China (PGJ), which tracks the fortunes of Chinese ADRs that trade on U.S. exchanges.

While Chinese stocks (PGJ) rallied strongly from October through late December, they gave back most of those gains in a strong downtrend from late December through the middle of February. Meanwhile, emerging markets stocks (EEM) remained in a long downtrend except for a few weeks in October and early November.
Both of these indexes are now above the lower of their 25- and 50-day moving averages, and EEM is well above both.

But the Chinese ETF has yet to see that lower (25-day) moving average turn decisively up. And we need both conditions to be met to get a buy signal.

The outperformance by the broad emerging markets ETF is evident when we look at individual stocks. The Chinese stocks that we think of as our old friends—Alibaba (BABA), Baidu (BIDU), Tencent Holdings (TCEHY) chief among them—have been range-bound for a long time. TCEHY was trading at its present price a year ago; BABA is net flat since September 2014; BIDU has netted zero since January 2014.

That’s not to say that these stocks haven’t enjoyed potentially profitable rallies in all that time. BIDU rallied from 147 to 152 between April and November 2014 and from 131 to 218 from September to November of 2015.

But we just haven’t seen the kind of long-term rally in Chinese stocks that we need to achieve the outsized gains that will repay us for the extra risk we take on when we invest in emerging markets.

This is reflected in our portfolio, which now includes a Mexican airport company, an Argentine bank, a South African miner, an Indonesian telecom, along with a Chinese education company, shipper and travel service.

By concentrating on the strongest emerging markets stocks we can find, irrespective of their countries of origin, we allow the market to tell us what to do rather than trying to impose our ideas of what ought to be happening.

So, should any stock in any country—even Russia, which is now pretty much radioactive for most investors—start to show strength (backed by sound fundamentals and an attractive story, of course), we will be all over it.

This is an excerpt from Cabot Emerging Markets Investor, which seeks to capitalize on the enormous potential in emerging market countries. Chief Analyst Paul Goodwin has been a researcher and writer for over 30 years and a member of the Cabot investment team since 2005.

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Paul Goodwin can be found on Google Plus.

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