Keep Your Eye on the Ball with Basic Investing Rules

When to get back into the Market

Three Basic Investing Rules

An Energy Policy Rant

Editor’s Note: Normally you’d hear from editor Paul Goodwin this week, but he’s on vacation, as I’m sure many of you are as well. So you won’t miss out on any of Paul’s great advice, I put together a few of his more recent writings that you may not have had time to read in all the chaos surrounding the holidays. From everyone here at Cabot, we wish you and your family a very happy and prosperous New Year!

The U.S. stock market has been showing a few signs of life recently, which is good.  I hope the period of catastrophic declines we’ve been going through hasn’t hurt your portfolio too badly (although I suspect the pain has been pretty widespread).

In fact, just about two weeks ago, we received a buy signal for the investment advisory I edit, Cabot China & Emerging Markets Report. But we’re not buying with both hands just yet; we’re taking things slow and slipping a toe into the market. Before the recent buy signal, the Report had been cutting back since the spring and was 100% cash for a while, heeding the message of the market.

It’s a message you probably read in these pages, too.  Every editor of Cabot’s growth newsletters has had the same advice.  I hope you took our advice to heart, because it is the only rational way to handle a negative market.

Markets don’t stay down forever, and this historic selloff has created a whole raft of bargain stocks.  There’s just one problem.

How do you know when to get back into the market?

Here’s an easy way to tell, one that’s based on one of Cabot’s powerful set of market timing indicators, the Cabot Tides.

This method will help you figure out when the market’s recovery is robust enough to make it worth your while to start investing again.  It won’t guarantee success for either the market or your individual investments, but it will put the odds in your favor and give you the confidence you need to overcome the aftereffects of this bearish period.

Step One: Get an online chart of the S&P 500 Index.  This will be available on most sites that feature finance sections.  Yahoo! Finance, use symbol ^GSPC, or StockCharts, use symbol $SPX, although just about any chart facility will do.

Step Two: Set the daily chart to show two moving averages, the 25-day and the 50-day.  Yahoo! uses pull-down menus, while StockCharts keeps its controls below the chart.

To get a new buy signal, you need two things:

First, the Index itself must rise above the lower of the two moving averages.  Today, the index is literally right on top of its 25-day line, just a few points above it or below it, depending on what time of the day you’re looking.

Second, the line for the moving average must be moving up.  Currently, the 25-day is starting to inch higher.

Both of these conditions must be met to produce a new buy signal.  When you get a buy signal, you can start putting your money back to work, although you will still need to follow the other rules for growth investing, such as buying on pullbacks, cutting your losses short, averaging up in your winners and stepping into the market gradually.

This indicator–I’ll call it the Simplified Cabot Market Timer–isn’t as finely tuned as the timing indicators refined by the Cabot Market Letter during its 38 years of publication, but it will serve you well if you follow its advice.

I have a friend who’s an avid tennis player, the kind of guy who routinely finishes high in his club championships and sometimes wins.  But he has always believed that with just a little advice from a top tennis coach he could be a truly great player. 

He got what he wanted (in a way) when he attended the 2004 U.S. Open Tennis Tournament in New York and got a great seat at one of the quarterfinal matches, in the second row behind the end line.  He realized that he was sitting two seats away from Andy Roddick’s coach (and brother), John Roddick.  This, he hoped, might be his chance to overhear what a top coach had to say to a top player.

And he did.

After Roddick lost the first two sets, his brother screamed at him during the changeover, “Keep your eye on the ball!”  Roddick eventually lost the match (to Joachim Johansson), but not before coming back to even the match at two sets apiece.

The lesson?  Even at the highest levels of any enterprise, the most basic things are still the most important.  If you’re looking for some inside trick that great growth stock investors use to make more money than the rest of us, you’re probably wasting your time.  There is no Holy Grail, no Philosopher’s Stone.

But if you asked my opinion on the most important basic rule, the one that’s the equivalent of “keep your eye on the ball,” I couldn’t pick one … but I could pick three.  And here they are.

1. Follow the market’s trend.  If you buy when the market is going up, you put the odds on your side, because a bull market changes the odds.  It’s always easier to swim with the tide or run with the wind at your back.  Stock markets are no different.  And when markets are going down, you should work extra hard to weed out your losers and move toward cash for the same reason.

2. Cut your losses short.  When a stock starts falling, you have no idea how far it might go.  The only theoretical limit is zero.  And the longer you stick with it, the less capital you have to put to work.  No matter how much it hurts–and it does hurt, I know from personal experience–you have to admit that you made a mistake and sell the stock when it reaches your sell point.  Cabot’s growth investing rules advise selling when you have a loss of 20% in bull markets and 15% in bear markets.  But these are the absolute limits; we often sell at a 5% or 10% loss if the market has turned sour or a stock is breaking down badly.  Calculate the sell point when you buy the stock, write it down and stick to it.  The number of times you get shaken out of a stock that then starts rising again will be more than made up for by the number of times you save your money to fight another day.

3. Let your winners run.  When a stock is showing a 20% profit, or 25%, or whatever, many investors will sell the stock and book the profit.  While booking a few smaller profits is fine, doing it across the board makes it impossible to enjoy the wealth-building benefit of a stock that doubles and then doubles again, which is how really enormous gains are made.  The profit from these big gainers, which reward you with compound growth, is what makes aggressive growth investing a winning proposition.  It takes just one of them to compensate you for a bunch of stocks that fall short.

There’s a reason that the same old rules are still the rules.  Keep it simple.  Keep your eye on the ball.  And you’ll come up a winner.

Now all we need is that bull market …

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I think of myself as a very reasonable man, and I don’t resort to the rant mode often.  It requires lots of energy and sheds very little light.  But with a watershed election just a couple of months behind us, I’ve been thinking more than usual about the national policies of the United States, and there’s one huge issue that just drives me nuts.

The issue is energy, and our national energy policy … or lack of one.  And that’s a crime.

After all, it’s not as if the recently-high cost and limited supply of oil just sneaked up on us.  Is our sense of history so stunted that the Oil Crisis of the 1970s is too ancient to be considered relevant?

We learned during the Oil Embargo, when OPEC was first flexing its muscles, that being dependent on foreign oil was painful, embarrassing and potentially disastrous.  Foreign countries used the biggest hammer they had to put several dents in our collective head, with economic consequences that lasted for years.

Accordingly, given that protecting our citizens from threats posed by foreign powers is the prime constitutional duty handed to those who occupy our highest offices, it became the primary duty of the federal government to take that hammer away.  It’s laughably obvious.

It was so obvious, in fact, that after a few years of cheesy miniature cars and a small burst of solar energy buildout, the entire alternative energy/energy conservation movement was allowed to fall off the national agenda.

The movement continued underground, but the federal government, the entity with the responsibility to protect our nation (and sufficient power to actually get the job done) just dropped the ball.

*No ambitious standards for automobile fleet fuel efficiency.
*No massive support for wind or solar or tidal or geothermal or even nuclear, for that matter.
*No game-changing commitment to railroads or public transportation.

And remember, this is not a matter of environmental or social policy, this is about the economic foundation of our economy and its vulnerability to foreign threats.

This ball has been dropped so many times by so many people that I can’t even figure out who to blame!  The administrations (of both parties) for not leading forcefully?  The legislative branch for caving in to lobbyists of auto and oil companies?  Regulatory agencies for slacking off on enforcing even the wimpy standards we have on the books?  Private citizens for acting like drunken pigs in a corn bin?

The private sector has been making progress, but it’s been irregular and unsupported.  It’s not really fair to expect giant oil companies to demonstrate a huge commitment to deploying technologies that will interfere with the sales of existing products.  The scientists at Big Oil and Big Auto have made some awesome discoveries, but the real breakthroughs (like First Solar’s reduced-silicon chips) have come from tiny firms.

What I think should have happened (and what I would like to see happen in the future) is for the U.S. government to make the kind of investment in energy independence that it has made in the Star Wars missile shield.  I think a case that can be made that freeing the United States from the reliance on oil from hostile nations stands a better chance of protecting us from our enemies than does an unreliable missile shield. 

I’m not a conspiracy buff.  I have no opinion on the notion that the U.S. is fighting in Iraq and Afghanistan to protect our oil.  Similarly, I have no real evidence that any car company has ever knowingly suppressed any technology that would have revolutionized the automobile, nor any oil company quashed a miraculous fuel saver.  All of these things may have happened.

The one thing I’m sure hasn’t happened is a burst of leadership and vision that can wean my country from its oil supply.  It’s matter of national security, and I hope to see it in my lifetime.

Sincerely,

Paul Goodwin
For Cabot Wealth Advisory

Editor’s Note: Cabot China & Emerging Markets Report was the first of the Cabot investment advisories to begin moving from cash to stocks in mid-December. If you’d like to participate in the exciting advance of the markets in China and the rest of the emerging world, a no-risk trial membership is just a click away.

http://www.cabot.net/info/cem/cemid05.aspx?source=wc01

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