Watching for Stock Leadership to Develop

It’s been interesting to watch the roughly parallel rallies that U.S. and emerging markets stocks have been staging since the middle of February. While the S&P 500 has been much stronger over the past year, iShares MSCI Emerging Markets (EEM) has actually pulled ahead since the beginning of March.

This is about what you’d expect, given that emerging markets are more volatile than the broad U.S. index. When investors are feeling ready to take on more risk, EM stocks lift faster than U.S. issues.

But what’s really interesting is that the impetus for the rebounds in the U.S. and EM indexes has followed roughly the same plan. Leadership has been provided by beaten-down sectors and stocks, while more traditional growth stocks have worked to make up their bigger corrections or just hacked around.

We’re coming to a point where the blue chips of the emerging markets sector—mostly Chinese tech and retail stocks, but also some stocks from other countries—are within striking distance of multi-month highs. And if they surge from here, we want to be ready to jump into these large-cap leaders as opportunities present themselves.

You can see what we’re talking about by looking at how the strong daily charts for some of these stocks compare with their more problematic weekly charts.

For instance, take a look at the daily chart of Tencent Holdings (TCEHY), a company with its roots in instant messaging services, but branches in games, value-added services, advertising, social media, online clubs, dating, music, etc. With a market cap of $191 billion, annual revenue of $14.4 billion, total cash of $11.1 billion and an after-tax profit margin of nearly 30%, this is a substantial company. (It’s the “T” in the BAT stocks, along with Baidu (BIDU) and Alibaba (BABA).)

Based just on the daily chart, you’d think that TCEHY was out to new highs and had a big head of steam. But the weekly chart tells a different story.

The weekly chart shows a stock in a long-term consolidation dating back to its highs in April 2015. The recent push to multi-month highs is tempting, but not necessarily conclusive, especially as so many other growth-oriented stocks are still on their launching pads.

We value the stocks of Old Friends whose scale, profitability, ambition and management make them easy to recommend. Right now, we’re waiting for decisive kickoffs from their launching pads before we jump in. In the meantime, we’re looking at stocks whose charts reflect significant enthusiasm from investors.

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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