Bailout Bonanza

Bailout, bailout, bailout … it’s all bailout all the time these days, with every news organization (financial or otherwise) reporting rumors and innuendos from every politician regarding the government’s bailout package.  Of course, the plan hit the fan in the House of Representatives on Monday afternoon, though the Senate passed it last night.  The House is expected to vote again by Friday.

What’s my take on the situation?  Honestly, I don’t know.  I want to believe that some type of bailout is going to help stem the tide of this mortgage mess, and I would guess it will.  But I also note that the Dow was down 250 points at midday, before the bailout vote failed on Monday–so it’s not as though investors were overjoyed about the package to begin with.

In these situations, I try to separate my emotions about this situation (which everybody has) from my investing decisions.  When it comes to the stock market, it’s usually best not to try to always understand WHY something is happening.  Of course, it’s natural to want to understand and know “why.”  But the funny thing is that those people always looking for answers often miss the market’s signals.

Thus, politically and personally, do whatever you want.  Write your representative and senator.  Talk with the family about the issue, or try to convince friends of your point of view.  Or simply watch cable news shows all night and fill up on the opinions of your favorite commentators.  All of that is fine and dandy.

But when it comes to making money in the stock market–our goal in this advisory, and in our various newsletters–you should keep your attention squarely on the market’s trend, and the action of potential leading stocks.  The market, as they say, tells its own story best.  Right now, that means playing defense, but it also means being prepared for the next bull market, something I’m reminded of when I think about the story I detail below.

Learning From Yourself and Others

One of the things I most enjoy about writing these advisories, and about writing and editing both Cabot Market Letter and Cabot Top Ten Report, is that what I’m writing about is REAL.  This isn’t academic theory, and at the end of the day, there’s always a scoreboard to see whether the advice was good or bad.

Moreover, I’m investing right along with you–making some great trades as well as plenty of mistakes, and learning all the while.  Ed Seykota, who made a fortune in futures, once said that he’s a trader who continually studies both himself and other traders.  Well, I try to do the same thing, and pass along the most helpful lessons I’ve learned from my own activities, along with tactics from other great investors.

And that leads me to March 2003, when the last bear market ended. 

After three years of pain (the market, remember, topped in March 2000), I had succumbed to pessimism.  I was perusing economic reports that told of worsening conditions.  I was reading bearish opinions on the market, based upon one fact or another.  I was using sentiment, a secondary-type indicator, as a reason to stay bearish.  Finally, I decided to back up my bearish stance with money.

(I specifically remember that most investors thought the start of the second Iraq war that year would spark a market rally.  My contrary thought was that the market would do the opposite and drop once the war began.)

Embrace Your Mistakes

I was already heavily in cash, as I had been for much of the bear market.  That was a good thing.  But I wasn’t content just to avoid any further decline–I wanted to profit from it!  In other words, I was getting greedy.  Moreover, instead of simply selling some stuff short, I decided to push my luck by using options.  Imagine!

Specifically, I bought a couple of put options on the Dow tracking stock (symbol DIA).  I did this despite the bottoming formations seen in the major indexes, and the relatively strong action in the Nasdaq, which remained well above its 2002 lows, the market took off on the upside!

In fact, the Cabot Tides and Cabot Trend Lines–our two trend-following indicators that kept us out of most of that bear market (and this one, too)–gave near-simultaneous buy signals in mid-March.  That was a powerful situation, and it should have, at the very least, had me selling my puts.

But I didn’t … and in fact, I bought more!  After all, I figured, this was just another in a long line of bear market rallies!

I could go on with a blow-by-blow account, but suffice it to say that I ended up averaging down on my put position a couple of times during the next few weeks, even though our indicators were positive.  It wasn’t until more than a month (and about 1,000 points on the Dow) later that I sold my puts and realized what a nincompoop I was.  And it was a good thing I did–the market really took off in May and June and didn’t look back.

Why share this story?  Because, if you’ve made mistakes in the past, you shouldn’t be ashamed of them–you should embrace them.  Those who learn from their mistakes in the market are the ones who make big money and improve their results.  Those who repeat mistakes over and over are left with sub-par results. 

It’s easy to say “prepare for the next buy signal” or “remain patient,” but until you’ve tried to do it and failed–as I did–it’s hard to realize the importance of such advice.  So take my word for it!

In my own situation, my big 2003 mistake has me content to sit in cash while the market sorts itself out.  (I’ve been doing a lot of that since the bear market started a year ago.)  And it also has me focused like a laser on any and all stocks that are holding up well and have solid growth stories (yes, there are some out there).  I know the work done these days–while most investors are panicking–will pay off many-fold when the bulls return.

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Admittedly, in terms of leadership, there’s little to get excited about right now.  But I do have two strong opinions.

First, I continue to receive emails from subscribers asking about stocks like Google (GOOG), Research in Motion (RIMM), Apple (AAPL), Baidu (BIDU) … you know, all the Nasdaq 100-type names that were big winners in the last bull market.  All these stocks are beaten down.  And many investors are thinking they’re so “low” now that they’re good buys, even if for just a trade.

I profess not to know what these stocks will do in the next couple of weeks.  But I do know that, at the end of the day, what you should be looking for are stocks and sectors that can make sustained upmoves over a period of two months, six months or longer.  And beaten-down, over-owned former leaders are not high-odds plays.

In fact, I wrote about this in the Cabot Market Letter two issues ago (when I advised selling First Solar (FSLR), another former leader).  On average, once big winners top, they fall 70% or more from their peaks.  Just to put that in perspective, to fall 70%, a stock must drop 25% … then drop 25% again … then drop 25% again … and, finally, drop another 29%!  Do the math–it’s true.  Trying to catch these falling knives, while always tempting, can burn you.

Biotechs Still in Pole Position

Instead, I’m content to find the groups that could lead the next upturn.  Are there any?  Yes … the biotechs and medicals.  One reason I’m favoring this broad sector is because most of these stocks really never led (and, hence, became over-owned by institutions) during the last bull market. 

Thus, there are fewer potential selling pressures during these bearish times–and we’re seeing that now, as most of these stocks continue to hold up well–and there are more potential buyers once the new bull market begins.

Some names I like include Alexion Pharmaceuticals (ALXN), which has triple-digit growth, a unique drug, and a stock that’s been building a base for seven weeks; Illumina (ILMN), the King of Genetics, which, despite a big run in recent years, is trading tightly; and United Therapeutics (UTHR), whose stock is in a flat-ish trading range, and with earnings that are up 100%-plus in each the past two quarters.

But the one I’ll highlight today is Cubist Pharmaceuticals (CBST), which made an appearance in Cabot Top Ten Report two weeks ago.  Here’s what I wrote:

“Cubist Pharmaceuticals is an interesting biotech company, with an established, rapidly-growing drug on the market and the potential for other hits in the quarters ahead. Right now, the company’s fortunes are tied to Cubicin, a once-daily  treatment, delivered via an IV injection, for complicated skin and subcutaneous tissue infections. Management believes Cubicin can be a $750 million drug in the U.S. alone, and it’s well on its way to doing that–already, more than 520,000 patients have been treated, and it’s been taking huge market share from its main competition (a drug called vancomycin). One analyst opined that because Cubist’s solution can treat some infections that vancomycin can’t, the $750 million goal might be conservative. The company is also in Phase II trials for a product that will lessen blood loss during surgery (a potential $500 million product), but in the near-term, Cubicin is producing great revenue and earnings growth, and analysts see another 50% earnings gain in ’09. It’s a good story.

The stock is consolidating in the 21-24 range, putting the finishing touches on a multi-year base.  A break above 24, along with some broad market strength, would tell me a new advance could be getting underway.

All the best,

Mike Cintolo

Editor’s Note: Cabot Top Ten Report, edited by Michael Cintolo, uses proprietary screening software to identify the market’s top-performing stocks.  Every week, you’ll get the 10 stocks that are under the strongest accumulation by big-money investors … you’ll find out why the stocks are being bought up … you’ll get a suggested buy range based on Mike’s chart analysis … and you’ll get an update on many previously recommended stocks, as well as the ability to email Mike with any questions you have.  Says Mike:  “I truly believe it’s the best source of new stock ideas available.”  If you want to invest only in the market’s top performers, subscribe to Cabot Top Ten Report today.

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