Nickels in Front of Bulldozers
Eggs vs. Tennis Balls
Two Strong Growth Stocks
Before I dive into what I’m seeing in the market, I want to start with a big-picture reminder. I’m writing about this now because volatility has gone through the roof, earnings season is underway (adding another layer of uncertainty and volatility) and pundits’ predictions and forecasts for the market are coming from all over the place.
All of this movement and all of these stories have one common impact on investors: it makes they want to DO SOMETHING. Do what? Well, that varies. Some want to jump back into growth stocks, others want to buy ETFs, others want to use options to play earnings season and some are looking to short the market because it’s “sure” to go way down from here.
Ironically, though, during these times, I think less is more. Granted, if you’re a short-term player, the current wild environment might be perfect. But I’m more of a position (intermediate- to longer-term) trader, and without a sustained uptrend, playing heavily in this market is, at best, like trying to catch a falling leaf when the wind is whipping. At worst, it’s like trying to stay dry in a driving rainstorm with a small umbrella.
I’m a bit suspicious of the market’s latest rally; it feels more like an oversold bounce that will eventually give way to more selling, rather than the start of a new uptrend. But in any case, there are few stocks in sustained uptrends, so just about any buying now is probably an effort to “scalp” a few points in a stock.
This is what is called trying to pick up nickels in front of a bulldozer, which doesn’t exactly offer a compelling risk-reward profile.
Sure, you might buy a stock right ahead of earnings, or simply jump into a couple of “oversold” stocks (whatever that means) and catch an updraft. But the potential profits are likely to be relatively small (maybe 10%?), and the loss potential is large (and can happen equally quickly).
All of this brings me to a market truism that’s important to keep in mind, one that I’ve written about many times: Over a few years or longer, it’s going to be your outlier trades (good and bad) that really count, while all of the small gains and losses tend to offset themselves.
Thus, while it feels good to grab a few extra nickels, the fact is that, even if you play the various swings correctly, the money you make isn’t likely to affect your overall results much. And if you play them incorrectly, you can get burned fast!
That’s why, right now, less is generally more-I see some enticing set-ups (which I write about below), but the big money is going to be made in the big swing when the market lifts off into a new, sustained uptrend. Until then, I’m steering clear of bulldozers.
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So if I’m not out there trying to buy and sell everyday, what am I focusing on? Research. Part of that, of course, is diving headfirst into analyst reports, online presentations and, nowadays, conference calls following quarterly reports.
But a lot of my work now also entails plowing through dozens of screens every day to identify the stocks that are acting best. The fact is, while down markets stink, it’s easier to spot real strength when most names have keeled over. That strength tells me that big investors are either hesitant to let go of shares or are building positions on dips.
Of course, I don’t just look for stocks near their highs-many of the “strongest” names right now are safe, defensive-oriented names, like utility, tobacco and insurance stocks. What I’m really looking for is the unusual … a growth stock with a good story that got nailed during the market’s meltdown, but has quickly snapped back now that the selling pressures have eased for a bit.
We call these stocks tennis balls; after hitting the floor, they bounce right back up. The opposite are what are known as eggs-stocks that break down, hit the ground, and stay splattered on the floor even when the market bounces. While most investors are attracted to the eggs (because they’re “cheaper”), history strongly suggests the tennis balls have a much better shot at becoming leaders.
One caveat here: I want to find stocks whose pullbacks were sharp, but reasonable, and have bounced back strongly. A name that fell 40% (such as many oil stocks) and has bounced back 10% is no leader.
So far, the good news (from my perspective) is that I’m seeing many tennis balls in the growth sectors, while the old world, commodity-heavy sectors contain a lot more eggs.
(Going off on a brief tangent, I was thinking about the major breakdown in both commodities and commodity stocks in recent weeks. It appears that it could be the final nail in the coffin of the huge secular bull market in these stocks that started back in 2003 or so. We’ve already seen gold and broad commodity indexes like the CRB in bear markets for a couple of years, and now other stuff is joining on the downside. This pattern has played out during history many times, and it’s usually a good thing for growth stocks … once the market returns to an uptrend. But I digress.)
For instance, let’s look at one of the hottest stocks of the past couple of months (and one I wrote about in Cabot Wealth Advisory recently), GoPro (GPRO). Overall, the stock ran from 50 to 98, then got yanked down to 68. Given the market’s meltdown (and just eyeballing the chart), I don’t think that pullback was completely abnormal-sharp, yes, but GPRO is not broken.
However, look at the stock’s action since the recent market low on October 15. Its bounce has been relatively modest in relation to its correction, and it’s come on very low volume. Full disclosure: I still have GPRO on my watch list, as the firm still has a big, mass-market story. Maybe it will kick into gear in the days ahead or maybe it will react well to earnings. Long-term, I think it could become a new leader.
While it’s not a horror show (take a look at some oil drillers for really bad charts), it’s a yellow flag that GPRO hasn’t snapped back well after its steep decline-big investors may have already accumulated all the shares they want, at least for the time being. Or maybe others are paring back, thinking GPRO’s valuation is too high for comfort. Whatever the reason behind it, I’d have to see more strength before deciding to jump in.
On the flip side is one of my favorite ideas right now, Palo Alto Networks (PANW). Fundamentally, it has just about all the makings of a winner, and chart-wise, it continues to impress. Notice, first, how PANW held up very well even as the market began to fall apart in late-September and early-October; heck, the stock popped to new highs on big volume on October 6!
Eventually, the market’s implosion was too much, and PANW fell a sharp 18% in just six trading days. Like GPRO, the dip was very sharp, but given the stock’s overall action, it was reasonable.
Now look at the stock since that dip-it’s been like smoke up a chimney, running right back to its old peak in the blink of an eye! Clearly, there were big investors adding to shares (and/or covering their shorts) on the dip.
Such straight-down, straight-up action in the stock (and, for that matter, the market as a whole) usually doesn’t lend itself to great buy points. More than likely, we’ll see some backing-and-filling in PANW, even if the market has seen its ultimate low.
But it’s this type of tennis ball action that you want to look for. When combined with solid fundamentals, it can be a tip-off to a new leading stock that will take flight when a fresh intermediate-term market uptrend gets underway.
For more updates on GPRO and PANW and additional 10 momentum stocks each week, take a risk-free subscription to Cabot Top Ten Trader. This year, we grabbed many double and triple-digit winners, including 303% gains in VipShop Holdings, 126% gains in Canadian Solar, 133% gains in Netflix, and we see many more strong stocks that have the possibility to be the next year’s winners.
Chief Analyst, Cabot Market Letter
and Cabot Top Ten Trader