A Quick Rant About the State of American Politics
4 Observations on the 2014 Stock Market
Is Alibaba (BABA) Buyable Here?
The current state of American politics is the worst I have seen in my considerably long lifetime.
It’s so bad that there’s not a single substantive thing I can say about any significant issue that will not be contradicted, resented and castigated by a large number of people. I don’t even want to try.
The most disappointing thing about today’s utter absence of civil dialogue on issues is that this polarization and incivility has been painstakingly engineered by political strategists who see it as a way to raise money and win elections.
The next-most disappointing thing is that raising money and winning elections are pretty much synonymous. If you can scare, outrage and incense enough people about what the other party is doing to America, you can reap the rewards in campaign contributions and spend your way to victory.
And the third-most disappointing thing is that the American electorate seems to be reconciled to the situation. But I digress.
I’m a stock analyst and I consider it my job to help subscribers make money by giving them good advice on what stocks to invest in and how to handle a portfolio with those stocks in it. And I’m good at it.
So I should probably stick to my knitting.
But when I voted this morning, I was nostalgic for the days when making my voting selections were sometimes difficult to make, when candidate’s arguments and positions would occasionally make me pause to consider before I inked my ballot. That was before cynical ideologues and strategists burned a no-man’s-land in the center of American politics.
I hope I live long enough to see some grass grow between the trenches again.
V is for Victory?
A quick look at the daily chart of the S&P 500 will prompt the thoughtful investor to wonder what the heck just happened here? After all, significant corrections are supposed to require a period of consolidation and base-building before indexes can get moving again. But the S&P just dropped like a rock for about four weeks, then bounced back even more energetically, making good on its September ascent above 2,000 in just three weeks.
I’m not a historian of the market (that honor belongs to Mike Cintolo, who seems to remember market moves the way mothers remember their childrens’ birthdays), but know that market bottoms (like market tops) are usually a process, rather than an event.
So what’s going on here? How does the S&P 500 drop 7.4%, the Nasdaq Composite scrub off 8.3% and then both growth indexes just shrug off the whole V-shaped correction and recovery like it never happened? (Those declines are on a closing basis. Intraday, the drops were closer to 10%)
As with many complex events that are subject to over-causation, I don’t think anyone knows for sure.
The correction itself isn’t tough to explain. The protracted rally in the S&P 500, for instance, had been running for almost three years. (I’ve picked October 3, 2011 as the start point for my chart and September 19, 2014 as my end point to dramatize the rally.) The chart shows the S&P zooming from 1,099 to 2,010.
It doesn’t take a genius to predict a correction after such a rally.
Unfortunately, not even a genius can predict when the correction will come or how long it will last. If you read commentaries from analysts during the September-October correction, you will see expert opinions about what will happen next that range from exuberant confidence to apocalyptic despair.
Here are my four observations on the Big V of 2014.
One: The correction wasn’t a surprise.
The months before the correction were rich in tells. There were divergences among major indexes, narrowing leadership among growth stocks and, perhaps most disturbing, a huge increase in the number of stocks on the NYSE that were hitting new 52-week lows.
But, following the old dictum among cautious economists that you should never put a number and a date on the same piece of paper, the duration and severity of the coming correction was a closed book.
Two: The same advance that increases the happiness and optimism of bullish investors makes bearish investors progressively uncomfortable.
An advancing market is a pain in the neck for value investors. They see valuations rising to unsupportable levels and they want out. But it’s hard to sell advancing stocks unless you’re extremely disciplined. Any bull market creates a growing pool of uncomfortable investors, some of whom are nervous because they have profits, and some because they’re just naturally pessimistic.
Eventually, the level of collective tension will rise to the point where a minor correction cascades into a major one in the same way a crystal thrown into a supersaturated solution will grow quickly into a much bigger one.
Three: Corrections are as necessary to a healthy market as forest fires are to a healthy forest.
Whether corrections are a response to overvaluation, overconfidence or irrational exuberance (or external economic factors like bursting asset bubbles), they are doing the market’s work. A fully mature market with stable leadership will bring in both good money and bad. Harvesting the mature growth and burning out the hot money is the market’s way of creating room for new leadership and new advances.
Four: (and perhaps most important) The market wants to take your money.
Over time it schemes to do what’s necessary to encourage investors to make wrong decisions.
By the middle of September, enough investors were feeling good enough about conditions that the markets were up to here in hot money. Confidence was high, and the market did what was necessary to take a lot of it away. And it charged a high price for the lesson.
Investors who bought too high, who didn’t have selling rules and who thought they were pretty darned smart began to look like a swarm of krill to a blue whale. Delicious.
I’ve left out of these observations the almost complete lack of alternatives to stock ownership for anyone with capital to invest. Bond yields remain derisory, and very few liquid investments can match the market for potential returns. When money wants to grow, the market beckons.
Lessons? Well, just the usual group of rules for growth investors. Buy well. Use stops, preferably mental stops. Let winners run, but take partial profits. Don’t ever think you’re smarter than the market.
There is also one Cabot-specific lesson, chief among them the use of market-following timing indicators to identify major shifts in market direction. Following the trend of the market isn’t that hard to do once you can assess it accurately. And basing your tactical investment decisions on what can be known accurately is a lot cheaper than making guesses about the future.
As to why the market popped back up so rapidly, that’s easy. Economic conditions are improving, the market’s traditional best time of the year is upon us and the natural optimism of investors (check the long-term charts of the major indexes for confirmation) just reasserted itself.
And those who had portfolio management rules in place-and the discipline to follow them-swept back in and began finding bargains in the burned-over district. So it goes.
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My stock pick for today should be no surprise. Alibaba (BABA) reported earnings this morning and the results were strong, with sales rising 54%. The stock’s earnings of 45 cents per share beat expectations by two cents and the number of active users of the company’s various online retail outlets grew to 307 million, up 105 million from last year.
BABA spent a few days last week idling under 100, and today’s breakout to new highs looks convincing.
Where to buy? Well, the combination of a strong market and a hot stock does create some challenges. Ideally, you would wait for a dip of a couple of points as some investors take a little profit. That may happen and it may not.
I’m recommending taking a small position in BABA, maybe half of what you would usually invest in a new stock. Hold it until you get a profit cushion of 10% or so and then buy another quarter of a position. If the stock gives you another 10%, fill the position.
As for the mental stop, I would set it at about 90. That was resistance back in September and October and it’s about 10% down from last week’s mini-base.
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Chief Analyst, Cabot China & Emerging Markets Report
Editor, Cabot Wealth Advisory