Still a Mess


With both Xi Jinping (who leads 1.3 billion people) and the Pope (about 1.2 million) visiting the U.S. this week, ceremonial and diplomatic activities are at a high level.

But while the Shanghai Exchange has been trading calmly sideways since its August 26 low, the U.S. stock market has suffered a small relapse. The S&P 500, which had been forming a rising wedge (flat highs and rising lows) since August 24, has now broken that pattern. The S&P has fallen back below its 200-day moving average, signaling that we may be beginning a retest of the August lows.

The iShares MSCI Emerging Markets ETF (EEM) is paralleling the S&P, rather than the Shanghai pattern, pulling back below its falling 25-day moving average after kissing its 50-day on September 17.

So, while it looks like China’s program of active buying support for the Shanghai Exchange is keeping the exchange on an even keel, the other economic news out of China isn’t so hopeful.

China’s manufacturing purchasing manager index (PMI), which was reported on Tuesday, registered further weakness in factory activity with a reading of 47.0. (Any reading below 50 indicates contraction.) The final August PMI was 47.3, and analysts had predicted a 47.5 this month.

The wave of discouraging news from Europe (mostly Greece), the Middle East (Russia making a move into Syria and no signs of progress in the battle against ISIS) and South America (Brazil’s economy deteriorating) leaves little room for optimism about the short-term prospects for either the economies or the stocks of emerging market nations.

The only rational response to this kind of situation has two parts. The first part is to keep plenty of cash on the sidelines and wait it out. After all, when the market’s action increases the probability that investments will fail, there’s no point in defying the odds. And moving to cash is what we’ve been doing.

But the second part of our plan for trying times is to build a watch list of attractive stocks in preparation for the market’s next upmove. (And if there’s one thing the market has taught investors over the years, it’s that an upmove always comes.)

We are especially interested in beaten-down Chinese e-commerce and online media companies, many of which have outstanding fundamentals and excellent competitive stances. When, as we anticipate, the Chinese market begins to recover, these stocks are likely to enjoy huge rallies following the recent beatdown.

Note: The economic turmoil in China has caused the government to curtail its approval for new U.S. IPOs by Chinese companies. This is partly an effort to calm its markets, and IPOs require excitement. But it’s also because the government appears to want new foreign offerings to succeed, and won’t give the go-ahead when market conditions are not propitious. We’ve seen scheduled waves of new offerings canceled in the past when conditions turned iffy.

We have to assume that there’s a backlog of companies who want access to U.S. capital, and it’s possible that the government will need only a minor improvement in market conditions before it opens the taps again. The upshot is that, when conditions do improve, many new, exciting companies could IPO soon after.

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

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This was an excerpt from Cabot Emerging Markets Investor, which seeks to capitalize on the enormous potential in emerging market countries. Chief analyst Paul Goodwin, Cabot’s international investing guru, provides your passport to profits.

Paul Goodwin can be found on Google Plus.

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