Too High to Buy?
Heading into Earnings Season
In my last Cabot Wealth Advisory, I spent a little time dispelling the myth that October is a truly scary month in the market–as it turns out, it’s more volatile than the average month, but the returns are about average, and far more Octobers end with gains than losses.
Today, because of some of the questions I’m getting from newer subscribers, and from some who attended my online seminar last week, I want to dispel a handful of other investment myths.
How do investment myths get started, and why are they widely believed? Mainly it’s because the market is a contrary animal–what seems like it would work in the stock market often does not (or, at least, not over the long run). Thus, most ordinary investors (and even some professionals) tout these beliefs, even though there’s no evidence backing them up. In fact, there’s plenty of evidence against them!
Myth #1: It’s no use buying higher-priced stocks because I can’t afford to buy many shares of them.
Truth: This is one of the most popular wrong-headed beliefs out there, and it’s one reason so many investors are attracted to lower-priced stocks. In the world of growth stocks, however, you almost always get what you pay for.
Remember this: Institutional investors, who control billions of dollars, are the ones who move markets. And they could care less about the price of the stock–they’re trying to find the best merchandise available, meaning the companies with excellent sales and earnings growth, revolutionary products or services, and bright prospects for continued growth.
Do you think they ignore a stock like Baidu (BIDU) just because it’s priced above 400? No! In fact, you know they’re not ignoring it, because the stock is acting exceptionally well, and the dollar volume traded each day is north of $700 million. Clearly the institutions are involved!
These big investors really view a $400 stock just like a $40 stock–except that the price swings will be 10 times as large. Of course, not every stock you buy will be 400, but the point is that you shouldn’t worry about how many shares you own; it’s meaningless. What counts is the dollar amount of stock you own–a higher-priced stock will move more points, but percentage-wise, it will move similarly to a lower-priced name. Your goal should be to own the best companies under the strongest accumulation, not stocks priced in your comfort range.
Myth #2: Stocks that have already had a major run-up from their lows are bad investments–they can’t continue to go up after such a big advance.
Truth: We’ve all been taught our entire lives that a bargain is a good thing, while only suckers pay top dollar for something. Indeed, many people are chastised for “splurging” on clothes or other goodies from a young age.
But as I wrote above, the market is a contrary animal, and as it turns out, buying strong stocks is the way to make big money. Why? Again, it’s because the institutional investors are trying to buy positions in the best stocks they can. That causes them to go up! And these big investors aren’t going to sell all their shares just because a competitor with a not-as-good-product is cheaper.
Now, you must buy strong stocks during periods of weakness; you shouldn’t buy after a stock has rallied 15% in just two weeks. You should try to buy after the stock has consolidated or pulled back 5% to 15% over a couple of weeks. But that’s different than betting on a stock that hasn’t budged during the past six months.
Also, you must consider the overall market. This year, the major indexes have rallied a huge amount from the oversold lows of March. Thus, if you’re searching for stocks that haven’t rallied much in recent months, you should be asking “Why haven’t they taken part during this super-strong rally?” If they haven’t, there’s probably something amiss.
In total, you’re better off identifying leading stocks and buying them during normal bouts of weakness. At some point, those leaders will break down, which is the time to sell most of your shares. But in a bull market, ignoring these leaders and focusing on laggards is a sure way to lose money.
Myth #3: The S&P 500 is trading at 50 times earnings, and thus this rally is a nothing more than a giant fake-out.
Truth: Market-wide valuation measures have rarely been useful in forecasting future market movements. What’s more important is investor perception of the future; if investors believe the future will be much better (economically and earnings-wise) than the past, then they’ll bid up stock prices.
Also, you must remember that many of the widely cited valuation measures are, first, based on trailing earnings (fairly meaningless since the market discounts the future, not the past), and second, often include one-time write-offs and other special expenses (not how most investors judge a stock).
Overall, market-wide valuation measures are almost always descriptive, not predictive.
Myth #4: If a stock heads up (or down) into its earnings report, it means it will report good (or bad) earnings. And that will be good (or bad) for the stock.
Truth: Trust me, I’ve studied earnings reactions five ways from Sunday and I haven’t found any consistent link between a stock’s performance heading into its report, and the stock’s performance immediately after the report.
The real key to earnings season is to have a game plan, something I write about frequently. Maybe you decide to sell some of all your growth stocks ahead of their reports. Maybe you decide to sell none, holding through earnings (as we do in our newsletters). Maybe you decide to sell some of those stocks that you don’t have a profit cushion on, while holding the stocks in which you do have a nice profit.
Whatever your decision, just make it and stick with it. Earnings season is more about portfolio management than divining a particular stocks’ reaction to its report.
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Back to the present market environment, one of the most well defined trends out there is the downmove in the U.S. dollar. If you look at the chart of the Powershares U.S. Dollar Index Fund (symbol UUP), it’s been steadily skidding for months.
Honestly, that is not my favorite scenario longer term–a strong economy usually needs a stable currency. (It doesn’t have to be rising, just holding its value compared to both other currencies and hard assets.) However, right now, the decline in the dollar is helping some U.S. multinational companies, as well as boosting the value of commodities, which were decapitated during last year’s market panic.
Let’s not forget, oil prices fell from $148 to $35 before rebounding, copper fell from $4 per pound to $1.25, and the broad CRB commodity index fell from 474 to 200. All of these measures have rebounded in recent months but remain miles from their old peaks. I think they have room to run, which will boost commodity stocks.
I’ve already mentioned gold stocks in my recent Cabot Wealth Advisories–gold bullion has broken out of an 18-month base, and gold stocks are following along. Agnico-Eagle Mines (AEM) and Buenaventura (BVN) are two of my favorites.
Outside of gold, a top name you should consider is Freeport McMoRan (FCX). The company has its hands in a few metals, but copper is the real driving force, making up more than three quarters of its revenue. And on that front, FCX could see earnings fly through the roof in the quarters to come.
As it turns out, worldwide copper inventories at this year’s trough in demand were an incredible 70% less than the inventory total at the last cyclical demand trough (back in 2002). And now demand is accelerating in a big way as the global economy gets back on track, especially in China. Moreover, the growth in supply is likely to be muted, as voluntarily idled capacity is small compared to the overall market.
All of this is the reason copper has rallied from its low of $1.25 to $3 in August. It’s now around $2.85, and has been consolidating for the past few weeks. If prices head materially higher, Freeport’s earnings are likely to crush expectations going forward–already, analysts have hiked their 2010 earnings estimate from $3.77 (90 days ago) to $4.53 (60 days ago) to $5.88 currently. Who knows how high it might go?
What’s the fly in the ointment here? My main apprehension is that EVERYONE is talking about the weak U.S. dollar here … and when everyone knows about a trend, it’s likely that it’s near an end (as the saying goes). If the U.S. dollar is going to embark on a countertrend bounce for a few weeks or months, it’s a safe bet that many commodities and commodity stocks will sag.
However, FCX itself is in fine shape. First, you should know that the stock is extremely well traded (it averages 14.6 million shares per day) and has terrific sponsorship. Second, the stock notched nine weeks up in a row starting in early July, and included in that run were five weeks of tight trading action–both signs of powerful support.
And third, during the market’s recent eight-day retreat, FCX dipped to its 50-day moving average … and then forcefully bounced off it to new recovery highs. With the 50-day line down near 68, we think FCX is buyable around here, or on normal weakness into the 70 to 73 range.
All the best,
Editor’s Note: More of Michael Cintolo’s expert advice can be found in Cabot Market Letter, our flagship publication, which has been steering growth investors to big profits for 39 years. Mike combines Cabot’s proven market timing and growth stock picking strategies to find the stock market’s biggest winners for his subscribers. In fact, Cabot Market Letter was recently named one of Timer Digest’s Top 10 Long Term Timers for two years. Don’t miss out on the leaders of the bull market. There’s never been a better time to invest. And if you subscribe to Cabot Market Letter by the end of October, you’ll get the rest of the year free!