Another Warning (and Why You Should Pay Attention)

Stock Market Video

Another Warning (and Why You Should Pay Attention)

This Week’s Fortune Cookie

In Case You Missed It

I have a nice little feature story on Moore’s Law that I think you’ll enjoy. But I also have a very caution flag to wave.

It’s not very specific, and it doesn’t make a great headline (like “The One Stupid Investing Mistake the Will Have You Eating Cat Food When You Retire!” Gotta love those sensational headlines.).

My warning is this: Watch it!

That’s all. Just watch it. And what I mean is that there is still a powerful strain of optimism in the investment community that’s not really warranted giving what the market is doing.

When we answer questions from subscribers, the Cabot analysts are always keeping track of what sentiment is like. And right now, the questions we’re getting are along the lines of “Can I go ahead and buy Tesla now?” and “Should I average down in Vipshop Holdings now that it’s down 20%?”

The big problem is that the market has been going up for so long that people forget that it can go down. Investors tend to be optimists, and the optimistic view is that the market has been through many pullbacks in the last couple of years and it has always resumed its uptrend within a month or two.

And that’s true, as far as it goes.

But what’s also true is that the market is a mechanism designed to remove money from the pockets of overly optimistic people and put it into the pockets of people who know the rules and follow them.

And the biggest rule of growth investing is: Control Your Losses!

How do you know if your violating the rule on avoiding losses?

• You are violating this rule if you own a stock but don’t have a plan for when you will sell it (and the will-power to actually follow through).

• You are violating this rule if you have a big loss in a stock but don’t want to sell it until it comes back up to your buy price.

• You are violating this rule is you have more than about 10% of your total portfolio in any one stock.

• And you are violating this rule if you aren’t paying attention to what’s actually happening in the market.

The recent volatility in the market has taken quite a few headline growth stocks off at the knees. It has brought some market indexes right up to the edge of a new sell signal, but hasn’t actually turned that corner.

But the price of reaping the big profits when markets are strong is paying attention to warning signals even after they have turned out to be wrong over and over. The market is quite happy to cry “Wolf!” as many times as necessary to get you to let your guard down.

My job is to warn you when markets appear to be teetering on the edge of a dangerous correction. And I will do that every time, not caring a bit that these warnings will frequently be wrong.

Your job is to take every warning seriously.

Now, here’s the little feature on Moore’s Law.

Back in 1965, Gordon Moore (then working at Fairchild Semiconductor, but soon to help found Intel) published an article called “Cramming More Components Into Integrated Circuits” in Electronics magazine. Moore predicted that the number of transistors on computer chips would double about every 18 months. Although he later amended the time scale for what would become known as Moore’s Law to every two years, it has remained The Law for 45 years. To put it in concrete terms, when Moore published his paper, the most advanced chips contained about 60 devices, while Intel’s hottest new chip, the Itanium, boasts about 1.7 billion (with a “B”) transistors.

You can thank Moore’s Law for your GPS-capable, picture-taking, video downloading cell phone, your kids’ hand-held, 3-D video games and a host of other chock-full-of-chips devices. You can also see it as the basis for the growth of the computer industry; if a device with double the power is going to be available in a couple of years, you’re going to need to trade in your old clunker for a new one a lot sooner than you’d like.

Moore has also noted that similar advances aren’t really possible in other industries. If carmakers had been making parallel strides, cars would get 100,000 miles to the gallon and you could buy a Rolls Royce for less than a Starbucks latté. Unfortunately, cars would also be about a half an inch long.

Chip designers say that they can obey Moore’s Law for a few more years, but then they’re going to run into some resistance from another set of laws, the laws of physics. Increasing chip density means that smaller chips with more devices will generate more heat but have less surface area to get rid of it. And if the infinitesimal circuits on chips continue to shrink, the thickness of the materials separating them will be so thin that electrons will start leaking through the boundaries!

Of course scientists are working on new ideas for processors and data storage and software. But the computer/handheld-device industry is built around Moore’s Law and the rapid turnover that it dictates. Spectacular advances in integrated circuits are so commonplace that the tech sector takes miracles for granted and expects consumers to throw out last year’s machines with the trash.

If Moore’s Law is going to lose traction, where will The Next Big Thing come from? The bumper stickers that you see in Silicon Valley that say “Please, God, Just One More Bubble” could go on the bumpers of lots of investors, too. The global recession and the surprisingly robust recovery in the stock market that followed seem to be at a crux, and nobody knows where things will go from here. This leaves stock investors looking for the companies that are ready to take the elevator, not the stairs.

I don’t have any more idea than you do of what The Next Big Thing is. The only Cabot advisory that really tries to do that is Cabot Small-Cap Confidential, whose Chief Analyst specializes in finding one Next Big Thing after another. If you have an appetite for getting into energetic small-cap stocks with huge potential before the crowd does, you should check it out.

For details, click here.

In this week’s Stock Market Video, I point out the unsettled state of the market and the relatively high number of leading growth stocks that have taken major hits in recent weeks. It’s a time for caution, tightened loss limits and only very careful buying. I also give a few stocks that are sailing along higher, not paying any attention to the market’s turbulence. Click below to watch the video. 

Here’s this week’s Fortune Cookie. Remember, you can always view all previous Fortune Cookies here and Contrary Opinion buttons here.

Tim’s Comment: Every age remarks on how much faster communication is now than it was previously. To me, this speeding up is a constant and therefore I can ignore it. What I like to rely on most in investing is the other constant, the fact that as humans, we will always swing—en masse—from optimism to pessimism and back again, and thus create large trends that can provide great profit opportunities.

Paul’s Comment: Here at Cabot, we don’t regard fear and greed as abstract notions. We see them as very real states that push stocks up and down. In fact, charts are nothing more than graphic representations of the battle between them. The danger in the market doesn’t come from times (like now) when the two are battling it out and making investors jumpy in the process. The real danger lurks in the extremes, when either one dominates. When fear is unopposed, markets tank. When greed is dominant, bubbles form and caution is thrown to the wind. It’s better to have the uncomfortable balance.

In case you didn’t get a chance to read all the issues of Cabot Wealth Advisory this week and want to catch up on any investing and stock tips you might have missed, there are links below to each issue.

Cabot Wealth Advisory 3/17/14—The Next Michael Kors (KORS)

Tim Lutts, the brains behind Cabot Stock of the Month, explains why he doesn’t care much about P/E ratios. He also runs down the sad history of Liz Claiborne and looks around for the next Michael Kors. Stock discussed: Kate Spade (KATE).

Cabot Wealth Advisory 3/18/14—Two Undervalued Stocks with Low Volatility

Roy Ward, who writes Cabot Benjamin Graham Value Investor, gives some tips on resources and screens on free websites he likes for researching stocks. He also gives his best screening parameters for finding value stocks. Stocks discussed: Baxter International (BAX), and PetSmart (PETM).

Cabot Wealth Advisory 3/20/14—Why Warren Buffett is Wrong

Chief Analyst Chloe Lutts Jensen of Cabot Dividend Investor writes in this issue about why Warren Buffett is wrong (about buying individual stocks) and right (about low-fee ETFs for investing in indexes and other assets). She gives several examples in a wide range of asset classes.

Have a great weekend,

Paul Goodwin
Chief Analyst, Cabot China & Emerging Markets Report
and Editor of Cabot Wealth Advisory


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