China Internet and U.S. Retail Stocks Investment Strategy: A.I. Allure Comes To Boost China. The Consumer Backdrop Slams U.S. Retail Stocks.
Post-Market Update: China Strat and U.S. Retail Stocks Strat.
Members,
I hope the first of June is treating you well. In this note, I want to provide a very brief update on what I’m seeing in China Stocks (like BABA), and also U.S. Retail stocks (which have largely been heavily sold off by investors).
Very recently, I shared my opinion quite directly that I believed China was primed for a bounce.
Look folks, in the investments world, I believe we can agree that we can never be fully sure of anything. New facts arrive every day for investors to digest, and from this continuous dynamic, comes different market pricing on stocks every single trading day of the year.
I do my best to keep the folks here informed of what I believe are signals, like I did last week with China.
There are many different types of market participants in the stock market - those who trade intraday, those who buy positions with the intent of selling over the coming days & weeks, and those who buy positions with the intent of holding on in the years to come.
Whichever timeframe you choose, I will do my best to provide directional opinions that you find helpful. Some ideas are shared in the spirit of shorter-term holds. Others are shared in the spirit for long-term investment.
Since my last China update, we have seen nearly a 7% surge in Alibaba from 78 to 83. While some Investors may not be excited about this move (given the long-term drawdown in this name), intermediate-term participants like myself are quite happy with moves like this.
This is because I position heavily at range lows (levels which I share with the folks here) and get close to cutting the entire stake at range highs or personal targets (which I’ve also shared with you). These ranges are all included in my Weekly Dashboard in addition to the contextual commentary I provide.
Whatever I discuss inside my Strategy letters is the same way I position. The only thing I don’t discuss is my specific size allocation because my circumstances may be different from my readers so I can’t comment on that, as that enters the realm of financial advice.
Generally speaking, it is safe to assume that if and when I see 7-20% gain on any individual name, I will cut the position by at least one half (especially if it occurred in a short period of time).
If I am underwater in a position, I will hold it if Support isn’t violated by more than 3-5%. If Support fails, I cut the position immediately. As a concept, Support is constantly discussed inside my letters. Inside our Dashboard, I provide Support ranges on my focus list of names.
In this post, I will give an update on the developments that are behind the China rally, whether this rally has legs, and also provide commentary on the U.S. Retail stock selloff that has sent the broad sector into disarray.
What is driving the China Rally? And is there more upside?
In a previous letter, I discussed that I was watching the Hang Seng (HSI) in order to inform my assessment on the China Internet stocks in the KWEB ETFs.
Specifically, I was looking for the HSI Index to reach 18253 as that represented a special level to me based on my methodology.
The Hang Seng Index reached that general neighborhood in Asian trading yesterday evening, and we saw a reaction in U.S. ADRs the following day (today).
See blurb below or feel free to reference it for later.
That’s the technical story.
Let’s discuss Macro and Fundamentals for a brief moment, which drive longer-term moves.
One of the areas that I believe can get Investors very excited about BABA (and the KWEB Components) is if there are signals from the Mainland that there will be further emphasis on A.I. development and prospective progress in this large total addressable market.
Today, we received an update that Alibaba Cloud is making further progress in its “LLM” (Large Language Model) called Tongyi Qianwen.
What we should understand about Alibaba’s business model is that Alibaba Cloud is is a critical business segment that Investors (like myself) are hoping to see become a larger and larger part of the overall business over time.
In the past, Investors have been disappointed by Alibaba Cloud’s seemingly slow progress. This latest quarter, the Cloud division reported that they were down by 2-3% year-over-year.
Not much to write home about - perhaps, until now.
As of this writing, I estimate Alibaba Cloud to represent about 8-10% of Alibaba’s entire company revenues. This division is also the 2nd largest in the firm, and is most likely going to be spun off per the spinoff news that we have been reading about.
If management executes well on Tongyi Qianwen (their Chat GPT-like product), I believe Investors could value the Cloud business at a higher multiple and that would result in a Sum-of-the-Parts valuation to be higher than the current multiple that the Street assigns BABA. There is ample demand from enterprises to use Tongyi Qianwen, and even if direct profit estimates cannot be ascertained at this time, we can assume that a large user base allows BABA (or BIDU & any other China tech platform creating generative AI products) to monetize this user base at some point in the future.
This of course is a long-term view. Valuation re-ratings based on network effects and new product roll outs take at minimum several months to take place.
In the near-term, our 78 trading entry opinion on BABA has been fruitful. Should we chase at 83 if we missed the 78 entry? Not if you’re a trader. Traders need to get in precisely at the best levels because as mentioned previously, one trading day in China can attribute a large amount of the entire Entry-to-Exit profit margin.
If you are an investor, and are willing to have a long-time horizon, then yes 83 still looks good to me. Just expect bumps in the road as 83 is a 7% premium from the level discussed last week.
I’m just super nit-picky about levels to share, and I strongly prefer to discuss levels that are low with the folks as it (somewhat) de-risks us from further market heat.
I’m now simply holding the positions until my targets are reached in the Dashboard. If, for some reason, we see a severe undercut of 78, I would interpret that as a Lower-Low, and that means we may see the low 70s region.
Traders can set a stop at 77-78 if they wish to exit at breakeven should the market turn very unfavorably. If I put on my investing hat on BABA, I wouldn’t set a stop-loss. 83 per share on BABA still looks very good to me personally if I were to have at least a 1-year time horizon (assuming no US-China war).
My view on BABA is made in conjunction with the KWEB components. Being positive on BABA is the same view as being positive on the stocks inside KWEB. Their correlation at the moment is very high.
U.S. Retail Stocks: Trash or Treasure?
It is no secret that Wall Street has discarded retail stocks in favor for A.I. stocks.
In fact, because I sometimes transact on shorter time frames (when the opportunity allows), I observe that on smaller time frames, when SOXX Components are being bought up, Retail Names simultaneously see immense pressure.
Humorously enough, these two chart depictions are happening at the same time of Dollar General and Nvidia.
What does this mean in simple terms?
It suggests to me that Money Managers are selling DLTR/DG/FIVE/ULTA/M/TGT (the Retail Stocks) to buy NVDA/AMD/AMAT/LRCX/AVGO/AAPL (The A.I stocks, to name a few).
Certainly, the fundamental developments coming out of the earnings calls from these retail companies have been less than ideal. Here’s what I heard when I listen to the earnings calls:
Sales Per Square Feet expectations need to be managed
Same Store Sales are coming in somewhat less than hoped
Gross Margins are stable for now but could be threatened later this year
Average transaction size per sale is falling
There is evidence of Inventory Shrink (a corporate term for missing inventory sometimes caused by theft or mismanagement)
And more.
For retail companies, these fundamental metrics discussed above are the key data points that Equity Research analysts use to upgrade or downgrade a stock in the retail sector.
So is the selloff justified in many of these names?
Yes, a selloff is definitely justified based on fundamental deterioration, but perhaps not to this extent and velocity from a technical basis.
This one quarter has shaved off 20-25% of the valuation multiples of several stocks that has a history of compounding earnings over longer time frames.
For example, Dollar General expects full year sales growth to be in the 1-2% region, disappointing the Street as consensus was 3-3.5%. This miss in sales growth forecasts caused the sales valuation multiple to contract back to multi-year lows and investors now pay less than 1X sales for Dollar General’s revenue outlook.
I’m interested in Dollar General at 150 and 155, respectively and believe if those levels hold, we could see a modest bounce to 165-170+ first before any further potential weakness. If 150-155 cannot hold, then this name is in more danger.
We saw thrift shop company FIVE Below (ticker: FIVE) bounce 3-5% after earnings today. I was previously looking for a 165 entry on FIVE, which was reached today.
FIVE shares sit at 175-ish after market. With LULU and FIVE reporting decent numbers, there may be a better day for the thrift shops and consumer stores tomorrow. That said, given the very weak macro Consumer backdrop, if I get any good bounce on these names like DG/DLTR/FIVE, I will take profits.
Cheers folks. If anything good comes across my radar (which is in my circle of competence), you’ll be first to know.
~Larry
Please make sure to read my 4-6 previous letters to understand my fundamental/technical/macro views. Every update builds on top of the others. I write quite frequently now so make sure to read many of my previous editions, which often also include valuable educational content to help you grow as an investor/trader. While I do enjoy sharing my personal journaling of the markets, this is not individual customized financial advice.
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