Waiting for Old Friends

Sometimes, ignoring what’s going on in the world can be an emotional survival skill. If you’re following every international story, you’re being hit with headlines about the potential British departure from the EU (the “Brexit”), the floundering economies in China, Japan and Russia, and the constant stream of data pointing in all directions about where these and other economies might be headed.

Right now, the one data point that seems to be having the greatest impact on global equity markets is the price of crude oil. The market’s big rally on Monday and the pullbacks on Tuesday and early Wednesday correlated quite well with news on crude supplies and the willingness (or refusal) of major oil producers to curtail production. Oil goes up, markets go up, and vice versa.

At the same time, investors, who are constantly voting with their buy and sell buttons, are finding plenty of things to like in the beaten-down stock markets.

Take, for example, Aluminum Corp. of China (ACH), which topped 17 in late April 2015. ACH went over the falls in May and its dive gathered speed in June. The stock’s decline began to slow in September, but the December and January market woes finally pulled it down to below 7 on January 15. It didn’t help that the company announced last October that it would shut down its biggest smelter—about an eighth of its total capacity—due to low prices.

A 60% collapse like that would create a very low P/E ratio if Chinalco (that’s the company’s nickname) had any earnings. But the company lost a massive $4.83 a share in 2014 and expects to book a seven-cents-per-share loss in 2015 and an 11-cent loss in 2016, which complicates valuation metrics. Still, however you calculate it, by February 2016, CHA was selling at a big discount to its April 2015 highs.

Investors obviously agreed, and ACH has rallied off its bottom to the tune of a 33% gain, back to above 9.

We generally don’t find an old-line, inefficient company like Chinalco an attractive investment candidate. But as a component of the benchmark index that we track to gauge the health of Chinese and other emerging markets stocks on U.S. exchanges, ACH’s rally has contributed to a nice boost. ACH, along with other beaten down stocks, has been part of the appreciation in the iShares MSCI Emerging Markets ETF (EEM) that gave us last week’s new buy signal.

But just as in the U.S. market, much of the strength has come from the bounce in the stocks that have been taken off at the knees, not from the expected future leaders. That’s one reason we haven’t yet responded to our new buy signal with any enthusiasm.

We continue to expect that the leadership in Chinese stocks will come from a small group of old friends that we were shaken out of during the latest correction. These are the giants in online retail, online gaming, online search and online messaging that we’ve been following for months and years.

The group includes Alibaba (BABA), Baidu (BIDU), NetEase (NTES), Tencent Holdings (TCEHY) and JD.com (JD). These are the companies with the national scope, the market share, the cash reserves and the technological expertise to take advantage of any improvement in the largest emerging market, China. They are all moving quickly to buy up competitors, move into complementary lines of business and build market share. The competition for the top spot on mobile device users’ browsers is fierce, and it will eventually pay off.

There’s also a secondary group represented by YY.com (YY) and Vipshop Holdings (VIPS) that have shown an ability to thrive, but don’t have the scale to battle for the top spots. We have many of these stocks on our watch list, and should we see convincing evidence of a breakout in any of them, we are prepared to buy them back at a moment’s notice.

But that won’t happen until the market’s uptrend accelerates and the stocks themselves start to put on some speed. Our subscriber will be the first to know.

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.

Subscriber comments on Cabot Emerging Markets Investor

Paul Goodwin can be found on Google Plus.

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